“Taming the bubble”: investors bet on Bitcoin via derivatives markets
Professor: "I really have no way of figuring out what a bitcoin is worth."
With trading set to resume on Mt. Gox in just a few hours, no one knows what will happen.
Bitcoin’s
biggest asset is also its biggest liability—no government or regulator
controls what people are willing to pay for a little piece of
nearly-anonymous computer code. That fact may partially explain why the
price of one bitcoin has shot up in recent days and weeks, only to come crashing down again on Wednesday.
On Thursday, Bitcoin’s largest exchange, Mt. Gox, suddenly suspended trading for 12 hours as part of what it described as a “market cooldown.” That pause is set to end at 9:00pm CT on Thursday evening.
It certainly doesn’t help matters that there’s new Mt. Gox-lookalike site serving malware. Also on Thursday, entrepreneurs Cameron and Tyler Winklevoss told the New York Times
that they hold approximately 1 percent—roughly $11 million—in bitcoins.
In short, Bitcoin may be poised to rise even further, or crash even
deeper and faster than ever before.
Ars contacted three major investment banks to inquire if
they had any bitcoin holdings—Goldman Sachs, JP Morgan Chase, and Credit
Suisse.
“We have no comment,” said Andrew Williams, a spokesperson for Goldman Sachs. JP Morgan Chase and Credit Suisse did not respond.
Some say that the recent rise of more advanced
bitcoin-related financial services, including hedge funds, futures, and
derivatives markets, could help stabilize the future of Bitcoin. This
week, a soon-to-launch New York-based “leveraged forex trading platform”
for Bitcoin, called Coinsetter, announced that it had received $500,000 in venture capital.
“In general, derivative markets tend to make prices more
stable rather than less,” Eli Dourado, a research fellow at the Mercatus
Center at George Mason University, who studies Bitcoin, told Ars. As
evidence of this, he cited the fact that the United States has banned onion futures since the 1950s, and the price has been volatile ever since as a result.
“An ability to bet that it is a bubble can help to tame the
bubble,” he added. “You can bet against the price increase. That said, I
think that bitcoin is still going to be really volatile. This isn't
going to fix that problem.”
Others are less than convinced of the crypto-currency’s bright future—derivative markets or no.
“It’s play money in the virtual casino,” said James Angel,
a business professor at Georgetown University. “Everybody else is
trying to outguess each other. Bitcoin has turned into a very large
multiplayer online game in which everybody is trying to out speculate
each other.”
The Maltese Falcon, aka, the Bitcoin Fund
These new ventures and derivative markets have a variety of names, including Exante’s Bitcoin Fund, ICBIT.se, and even TorBroker, a Silk Road-style “hidden website” that requires Tor to make stock trades.
Exante is likely the most
bona fide of these operations as it is an official, licensed,
Malta-based brokerage company with a real office, real employees, and
the power of European Union regulators behind it. Earlier this year, its
“Bitcoin Fund” became the world’s first bitcoin-based hedge fund and is based in Bermuda, a notorious offshore tax haven.
“Similar to Exchange Traded Funds, the Bitcoin Fund objective is to purchase and store BTC; 1 Bitcoin Fund Unit = 1 BTC,” the site states.
“The investment objective of the Fund is to achieve capital gains in
the Net Asset Value of the Fund Shares. The fund currently manages a
portfolio of 81,000 BTC and has achieved a phenomenal +1000% return in
its short 3-month history.”
Reached by phone in Singapore, Anatoliy Knyazev told Ars
that the “Bitcoin Fund” was a “nice addition” to the mix of existing
funds and other financial transactions that the company offers.
Americans, due to existing regulations, can’t invest in the Bitcoin Fund
just yet, but a “feeder fund” is set to be ready in a few months.
“We have alternative funds that invest in wine, real
estate,” he said. “Bitcoin as a share of our business is growing but
it's [still small.] We have 82,000 BTC in the fund—today that’s almost
$20 million. To compare it with the rest of our business it might be
trickier. Our hedge fund market is about $2 billion. What's important is
the amount of return that we get from Bitcoin. In January we had
subscriptions, we tried pitching Bitcoin last summer and autumn with
mixed results. After the price appreciation in January from 10 to 20
[dollars per bitcoin] we were overwhelmed with people wanting to get
in.”
Knyazev added that his investors were other hedge funds and “high net-worth individuals.”
“Let’s say you invest $1 million, and from that we purchase
bitcoins. You're issued the fund shares, so you get 100 shares. After
that we take custody of them, geographically distributed,
cryptographically secured. The encrypted flash drive copies [of the Bitcoin wallet itself] are kept in bank safes [in Moscow, Singapore and Switzerland.]”
Shorting bitcoin
But while Exante may be the best example of what’s out
there in terms of bitcoin-based investments, there’s also some pretty
sketchy stuff too.
Alex Stukalov is one of the “roughly four people” behind ICBIT.se,
a Russia-based site, who operates under the shared handle “fireball.”
ICBIT has been in operation since November 2011, boasting 5,000
registered users, with “around 100” online at any given time.
Stukalov, who spoke to Ars via Skype text chat, said that a
well-known Bitcoin user in Vietnam named named “Tycho” (who has also
been publicly accused of “cheating”
the entire Bitcoin network) receives some of the revenue from the site
and acts as a consultant. He claims that in six months, the team has
taken in roughly 2,000 BTC in revenue (approximately $300,000 at $150
per bitcoin). But, he says, all that money has been put straight back
into the company.
“The profit inflow is not really that stable. Even more, we
put all money currently taken from fees into the so-called ‘reserve
fund,’ which should cover exchange from default,” Stukalov said. “And
currently, during recent rate volatility, that reserve fund was heavily
exhausted.”
“The best statistics [are] the total volume and open
interest (quantity of contracts currently bought/sold). So, counting in
dollars (1 contract = $10), total volume for all three contracts for the
recent three months is $1.4 million.”
ICBIT is one of the few places on the Internet where
investors can engage in a futures market, effectively betting on the
upcoming exchange rate from bitcoins to dollars. On its site,
it also says: "ICBIT currently is in process of incorporating in an
offshore jurisdiction. If you are a lawyer willing to help us - please
let us know, we need your help."
Ars spoke to three traders on the site on Thursday
afternoon, who identified as a Dutch business student, a Los
Angeles-based IT manager, and a French scientist who recently finished
his doctorate in bioinformatics and was headed to a new job in Brazil in
new months.
Simon Gorter, the Dutchman who goes by the online handle
“chipsticky,” told Ars that he had only bought 0.6 BTC “a few days ago”
and used it to “short a position,” effectively betting that
fraction-of-a-bitcoin’s exchange rate would go down. In just a few days,
he claims to have tripled his money to 1.8 BTC, currently worth roughly
under $300.
“I’m still a student,” he added “I do online poker as well,
but just got interested in this Bitcoin hype and looked at the charts
and realized how crazy it was. Sure, I’m trying to profit, but just for
small money. It’s more like a game for me, to see if I am right about
the market.”
When asked if he was “long” on bitcoin—believing that its value will increase over time—he had a decided answer.
“I’ve thought about it a lot last few days, and I came to
the decision that its a bubble that will burst,” the University of
Groningen business student said. “The question is, how high can it go
before it does? I think there is a good chance it already did and will
drop even further. Another possibility is that the mainstream media has
brought a lot of interested people willing to buy a few coins which
could cause another boom going way higher than the last high before the
bubble will burst.”
The Los Angeles-based trader, who goes by the online handle
“bV” openly accused Stukalov and the others behind the site of
“manipulating” the future price in the middle of a given futures
contract.
“I figure my only recourse is to just going to keep buying
until I run bust and stick the exchange with the debt,” he said, noting
that in the worst-case scenario, he would lose his original investment
of $1,000. “Since I can't get my money out, I can at least bet on a
quick recovery!”
Stukalov dismissed such allegations, saying that they followed norms for futures markets.
“We do stuff the right way,” he said. “We have several
people with background in finances and stock market trading
participating in ICBIT development, we know how to do it really
properly, not amateurish. And we stick to what we say (it's even obvious
from the ratio: there are about three upset people now, out of 5,000
registered, and around 3,000 trading)”
But, ICBIT has no listed legal address, nor a listed
mechanism through which to adjudicate disputes. Plus, it wouldn't be
hard to imagine a scenario where someone shorts Bitcoin, then launches a
distributed denial of service attack on Mt. Gox or another exchange,
causing chaos in the market, and likely, profiting.
How do you value one bitcoin, anyway?
The reliability of bitcoin-related businesses is precisely
that problem. Hardly anyone in the world gets paid in bitcoin, and
hardly anyone is selling goods in bitcoin. Sure, you can buy stuff from Bitcoinstore.com or any other similar site, but nearly all goods there are based on exchange rates with traditional currencies.
“Even if there is a speculative element [with traditional
commodities], at the end of the day you expect the price to have a
gravitational pull towards the true value," James Angel, the Georgetown
professor, added.
"We have models for valuing stocks and bonds, so we can get
a sense of what it’s worth. But I really have no way of figuring out
what a bitcoin is worth. Sure, I can go to exchanges and see what the
current price is, but how do I know that that price tells me anything?
If I look at the price of the euro, I know what I can buy with euros. I
know how many euros it takes to get a Big Mac in Paris or a hotel room
in Frankfurt. We have this idea called ‘purchasing power parity’
that says that sooner or later exchange rates should reflect prices
across different exchanges. We don’t have that with bitcoin.”
Plus, he added, traditional commodities like gold, oil,
wheat, and others have practical value beyond their monetary value. Gold
can be used as jewelry, or manipulated industrially to manufacture
semiconductors. Oil can be used to power machinery or refined for
gasoline. Bitcoins have zero inherent utility.
“The demand for bitcoins can be driven by either its
usefulness as a medium of exchange or a store of value,” Irfan Emrah
Kanat, a doctoral student studying virtual currencies at the W. P. Carey
School of Business at Arizona State University, told Ars. “Bitcoin is
not accepted on Amazon or in the corner store, so its use as a medium of
exchange [is] limited.”
And sure, if you take the opinion that bitcoin is more like
a fiat currency (like the US dollar), which isn’t based on anything
either (we went off the gold standard decades ago), it has a massive
infrastructure designed to regulate and safeguard its function as a
currency through institutions like the Federal Reserve, the Treasury
Department, the Securities and Exchange Commission, the Commodity Futures Trading Commission and other entities.
“The bank that is storing my money is highly regulated by
federal regulators and backed by a government with a huge army behind
it,” Angel added.
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