Tag Archives: Bitcoin

Bitcoin’s rise is no joke, it is a sign of the failure of financial services

Bitcoin’s rise is no joke, it is a sign of the failure of financial services

Bitcoin’s surge past $17,000 late last week reinforces an important economic theory: a rapidly-expanding asset bubble will always draw a crowd. But it should also reinforce fears about a situation that is not limited to a few foolish retail punters and a few swashbuckling hedge funds. This is a crisis for financial services.

The cryptocurrency’s rise is a source of much hilarity for most of finance, reminding us that you can always count on dumb money. But financial institutions — exchange operators, derivatives clearing houses and others —have now joined the party, taking a slice of business from bulls and bears alike. Today, Cboe Global Markets began allowing investors to trade bitcoin futures, and the CME Group will follow suit on the 18th.

As a result some are worried about whether bitcoin could present a systemic risk. The phrase ‘next Lehman Brothers’ has been tossed around with willful abandon, by observers including Interactive Brokers chairman Thomas Peterffy, whose company is one of the US’ largest derivatives traders. Peterffy took out a full page advert in the Wall Street Journal to demand that regulators force any organisation clearing bitcoin derivatives to be ring-fenced from other types of derivatives clearing.

“Cryptocurrencies do not have a mature, regulated and tested underlying market,” Peterffy wrote. “The products and their markets have existed for fewer than 10 years and bear little if any relationship to any economic circumstance or reality in the world.”

He is wrong, on two counts.

Firstly, the idea that bitcoin could present a risk to the financial system itself is laughable. The financial crisis was prompted by a huge repricing of risk; the near-religious belief that the US housing market was safe as, er, houses — held by almost all of the financial industry — was suddenly challenged. But those selling bitcoin options are under no illusions that it could implode in minutes. In that sense, it is more like an emerging market currency that is one half of a hedge fund’s carry trade, and the world doesn’t end every time a heavily leveraged shop blows itself up on a wrong-way bet.

There is a reason why exchanges are demanding investors hold 35% of the value of their futures contracts in cash with the exchanges — far higher than other assets. They have no illusions about the risks involved in handling an asset that is about as volatile as nitroglycerin.

Peterffy is also wrong about bitcoin’s relationship to the real world. In fact, its rise is finance’s existential problem in microcosm: when the financial crisis burned investors and required gigantic taxpayer bailouts, the effect was that retail money fled from traditional investments, and asset managers say it has been slow to come back. While the S&P 500 has returned 269% since 2009, a report in late 2016 by the CFA Institute found nearly a third of all investors were predicting a market crash within three years. BlackRock chief executive Larry Fink estimates there could be as much as $55tn uninvested.

But while institutions have now decreased their cash allocations to 4.4% – the lowest reported cash levels since 2013 – according to a fund manager survey by Bank of America Merrill Lynch in November, the climate of fear among retail investors remains very real.

Liz Ann Sonders, chief investment strategist for US wealth manager Charles Schwab, told the New York Times last month that retail investors have nowhere near the commitment to stocks that they did in past booms. One investment adviser quoted in the piece said that he had pleaded with clients to put money into the stock market, but that all they wanted to know was when the next crash would come. “No one ever asks me when the S&P is going to blow past 3,000,” he said.

A great many people simply do not trust the financial services industry to look out for their interests, and with so much money still “on the sidelines,” it is fair to assume many people believe bitcoin to be more trustworthy than the stock market.

When it blows up, they will despise bitcoin too. But that is not a problem. The fact that they apparently despise the finance industry, so much that many of them would shun a simple mutual fund in favour of bitcoin — whose annualised volatility against the US dollar is a whopping 97% — is a serious problem.

There is only reportedly around $200bn in digital assets, which is small compared with the wider markets. But the existence of that cash, and its stubbornness in staying out of equity markets despite a record-setting bull market, is proof that something is still terribly wrong in the world of finance. Many asset managers believe that retail investors will eventually overcome their post-crash fears and get back in the game. History suggests as much. But if this time really is different, the next challenger to traditional finance — one that could be less volatile and more of a sane investment — will be harder to ignore.

For now, the financial services industry can go on and laugh as the rubes eagerly line up to surrender their hard earned money to hackers and short-term traders who are likely making millions exploiting the arbitrage opportunities among the various quoted prices. But remember that their rising fortunes are just further proof of finance’s falling ones.

Vanguard successfully tests blockchain for market data

Index provider issued data to the funds using the distributed ledger technology to reduce human error

Vanguard, the $5tn asset manager, has completed a blockchain technology project to provide a range of its index funds with up-to-date market data.

As part of a pilot project lasting several months, the world’s second largest asset manager used the distributed ledger technology, which underpins cryptocurrency bitcoin, to feed funds with market information and eliminate the need for manual updates.

Currently, the transmission of index data, such as changes to important company information, relies on multiple parties and distribution channels. It can also often require manual updates, which increases the risk of human error occurring.

Vanguard partnered with the University of Chicago Business School’s Center for Research in Security Prices — the indices of which Vanguard uses for the funds trialling the new technology — and New York-based technology provider Symbiont for the project.

During the testing phase, CRSP distributed daily index data to 15 Vanguard funds through Symbiont’s blockchain platform.

Warren Pennington, a principal in Vanguard’s Investment Management Group, said: “Using this platform, investment managers will be able to instantly distribute, receive and process index data, resulting in better benchmark tracking and significant cost savings that potentially results in better returns for our clients.”

Vanguard’s blockchain pilot comes as other investment giants begin to explore the benefits of using the technology.

AQR, the $208bn quantitative hedge fund, recently told Financial News it is looking into the potential uses of blockchain for trading, while Dutch pension funds APG and PGGM are working on a project to use the technology to reduce the cost of back-office administration.

In February, Northern Trust and IBM built a blockchain to modernise the administration of a private equity fund managed by Unigestion.

Here’s what’s driving bitcoin buyers’ rush to ‘millennial gold’

A client jokingly told me that his biggest gripe with me in 2016 and 2017 was that I didn’t buy him any bitcoin. I told him not so jokingly that if I bought him bitcoin, he’d be right to fire me.

Maybe I’m a dinosaur; but, like gold, bitcoin BTCUSD, +19.54% is impossible to value. What is it worth? It has no cash flows. Is bitcoin worth $2, $200, or $20,000?

But Wall Street strategists have already figured out how to model and value this creature. Their models sound like this: “If only X percent of the global population buys Y amount of bitcoin, then due to its scarcity it will be worth Z.” On the surface, these types of models bring apparent rationality and an almost businesslike valuation to an asset that has no inherent value. You can let your imagination run wild with X’s and Y’s, but the simple truth is this: bitcoin is un-valuable. Moreover, in my view, bitcoin is in a bubble.

In 1997, when Coca-Cola’s KO, +0.02%  stock valuation started to rival some dot-coms, bulls used this math: “The average consumer of Coke in developed markets drinks 296 ounces of Coke a year. These markets represent only 20% of the global population.” And then the punchline: “Can you imagine what Coke’s sales would be if only X% of the rest of the world consumed 296 ounces of Coke a year?” Somehow, the rest of the world still doesn’t consume 296 ounce of Coke. Twenty years later, Coke’s stock price is not far from where it was then — but on the way it declined 60% and stayed there for a decade. Coke, however, was a real company with a product, sales, a real brand, and tangible, dividend-producing cash flows.

If you cannot value an asset you cannot be rational. With bitcoin above $11,000, it is crystal clear to me, with the benefit of hindsight, that I should have bought bitcoin at 28 cents. But you only get hindsight in hindsight. Let’s mentally (only mentally) buy bitcoin today at $11,000. If it goes up 5% a day like a clock and gets to $110,000 — you don’t need rationality. Just buy and gloat.

But what do you do if bitcoin’s price falls to $8,000? You’ll probably say, “No big deal, I believe in cryptocurrencies.” What if it then goes to $5,000? More than half of your hard-earned money is gone. Do you buy more? Trust me, at that point in time the celebratory articles you are reading today will have vanished. The awesome stories of a plumber becoming an overnight millionaire with the help of bitcoin will not be gracing social media. The peer pressure to own bitcoin will be gone, too.

Then you’ll be reading stories about suckers who bought bitcoin at the all-time high. And then bitcoin will tumble to $2,000 and then to $100. Since you have no idea what this crypto-thing is worth, there is no center of gravity to guide you or anyone else to make rational decisions. With Coke or another real business that generates actual cash flows, we can at least have an intelligent conversation about what the company is worth. We can’t have that with bitcoin. The X times Y = Z math will be reapplied by Wall Street as it moves on to something else.

I can understand the original bitcoin aficionados. The global economy is living beyond its means and financing its lifestyle by issuing a lot of debt. Normally this behavior would cause higher interest rates and inflation. But not when you have central banks. Our local central bankers simply bought this newly issued debt and steered global interest rates down to near-zero levels (and in many cases to what would have been previously unthinkable negative levels).

The logical inconsistencies and internal sickness of the global economy have manifested themselves into a digital creature: bitcoin. The core argument for bitcoin is not much different from the argument for gold GCQ8, -1.03%  : central banks cannot print it. However, the shininess of gold has less appeal to millennials than bitcoin does. They are not into jewelry as much as previous generations; they don’t wear watches (unless they track your heartbeat and steps). Unlike with gold , where transporting a million dollars requires an armored track and a few body builders, a nearly weightless thumb drive will store a dollar or a billion dollars of bitcoin. Gold bugs would of course argue that gold has a tradition that goes back centuries. To which digital millennials would probably say, gold is analog and bitcoin is digital. And they’d add: in today’s world the past is not a predictor of the future.

Bitcoin started out as “millennial gold” — the young (digital) generation looked at it as their gold substitute.

In fact, bitcoin is really two things: a blockchain technology and a (perceived) currency. The blockchain element of bitcoin may have enormous future applications: electronic contracts, voting, money transfers — the list goes on. But there is an important misconception about bitcoin: ownership of bitcoin doesn’t give you ownership of the blockchain technology. Someone without a single bitcoin owns as much bitcoin technology as someone with a million bitcoins; that is, exactly none. It’s like when you have $1,000 on a Visa debit card: That $1,000 doesn’t give you part ownership of the Visa network unless you actually own Visa

 V, -0.01%   stock.

So owning bitcoin gives you a right to — what, actually? Digital bits?

People are buying bitcoin now for one simple reason: FOMO — fear of missing out. This behavior is so predominant in our society that we even have an acronym for it. Bitcoin is priced above $11,000 because the fool who bought it for $11,000 is hoping that there is another, greater fool who will pay $12,000 for it tomorrow. This game of greater fools is not new. The Dutch played it with tulips in the 1600s — that did not end well. Dot-coms took the game to a new level in the late 1990s — that also ended in tears. And now millennials and millennial-wannabes are playing it with bitcoin and other competing cryptocurrencies.

TimeBitcoin USDJan 17Mar 17May 17Jul 17Sep 17Nov 17

US:BTCUSD
05,00010,00015,00020,000

The counterargument to everything I have said so far: those dollar bills in your wallet or digitally residing in your bank account are as fictional as bitcoin. True. Currencies are stories that we all have (mostly) unconsciously bought into. (I highly encourage you to read my favorite book of 2015: “Sapiens,” by Yuval Harari.) Of course, society and, even more importantly, governments have agreed that these fiat currencies are the means of exchange. Also, taxation by the government turns the dollar bill “story” into a physical reality: Governments will not accept bitcoin to pay your taxes.

Governments also tend to look at bitcoin and other cryptocurrencies as a threat to their existence. First, governments are particular about their monopolistic right to control and print currencies — this is how they can overpromise and underdeliver. No less important, the anonymity of cryptocurrencies makes them a heaven for tax avoiders — governments don’t like that. The Chinese government, for example, outlawed cryptocurrencies in September 2017. Western governments most likely are not far behind. If you think outlawing a competitor can happen only in a dictatorial regime like China’s, think again. This can and did happen in the U.S. With an executive order in 1933, President Franklin D. Roosevelt made it illegal for the U.S. population to “hoard gold coin, gold bullion, or gold certificates.”

Of course, nothing about bitcoin’s bubble will matter until it does. Bitcoin may soar to $111,000 from $11,000 before it comes down to earth. That is how bubbles work.