gadfly

Mar 25 2018

A Hedge Fund Billionaire’s Bitcoin Bet

Bitcoin continues to redefine the word volatility. The cryptocurrency is down more than 50 percent from its December peak; but that still leaves it up more than 600 percent from its value a year ago.

The Wildest of Rides

Bitcoin's rollercoaster journey shows no signs of stabilizing

Source: Bloomberg

On Thursday, it dipped below $8,000, marking a decline of more than a third this month alone. Its fellow digital currencies including Ripple and Ethereum have inflicted similar losses on holders — or hodlers, as crypto-fanatics call the ever-bullish aficionados who grin and bear their losses in expectation of a renewed rally.

The renewed slide comes after my Bloomberg News colleagues Alastair Marsh and Nishant Kumar reported on Wednesday that billionaire hedge fund manager Alan Howard made "sizable personal investments" in cryptocurrencies and associated technology last year. Some of his fellow partners at Brevan Howard Asset Management have also put their own money into the new-fangled structures, they reported.

There's a warning here to others: billionaires can afford to dabble where mere fiscal mortals should fear to tread.

The ultra-rich can almost certainly afford to lose every cent they punt on digital currencies without affecting their lifestyles. A survey of Bitcoin owners published by Lendedu in December, however, found that 22 percent of those using credit cards to finance their purchases hadn't repaid their balances.

Using borrowed money to speculate on cryptocurrencies is the equivalent of taking your entire personal net worth to the casino, where the odds are always in favor of the house. No wonder some major financial institutions such as Bank of America Corp. and JPMorgan Chase & Co. have outlawed crypto purchases using their plastic.

Secondly, digital currencies remain speculative gambles rather than investments, at least for now. Hedge-fund managers (well, the successful ones) will be well-aware of the academic literature in behavioral economics of tendencies such as confirmation bias, fear of missing out and loss aversion – something that devotees of Bitcoin and its ilk seem to be blissfully ignorant of.

Thirdly, the regulators are circling. The U.S. Securities and Exchange Commission is investigating hedge funds set up specifically to participate in digital-token sales. Markus Ferber, the lead European Union lawmaker on the MiFID II suite of rules, said earlier this week that virtual currencies should be classified as financial instruments and fall under those regulations to protect investors.

One avenue open to the overseers of finance would be to restrict cryptocurrencies to sophisticated investors. That would anger the many libertarians who extol the virtues of the likes of Bitcoin as offering a store of value outside of the purview of central banks; but it would instantly shrink the pool of subscribers available to the purveyors of initial coin offerings, to the detriment of their subsequent valuations.

"Let me tell you about the very rich," F. Scott Fitzgerald wrote in a short story published in the 1920s. "They are different from you and me." That statement is as correct today as it was almost a century ago; and it should serve as a warning to anyone planning to belatedly jump on the cryptocurrency bandwagon.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Dec 13 2017

Bitcoin Has Some Bad News, and Nobody Cares

What would dampen a buyer's enthusiasm for Bitcoin, the cryptocurrency whose uncharted, speculative price bubble has eclipsed history's tulip manias and gold rushes?

Three things come to mind: a security breach or theft, a major retailer warning against its patchy record as a method of payment, and a cooling of Wall Street's already frosty view of the coin.

So far this week, all three have happened. Yet Bitcoin simply doesn't care. Its price has now crossed the $15,000 threshold, double where it was trading only a month ago. What does this tell us?

Firstly, that the reality distortion field surrounding Bitcoin — a craze that reflects a broad desire to get rich, beat the establishment and take back control of the financial system — is expanding.

Hacks and thefts, such as the $31 million recently reported stolen by Tether, have hurt the currency's price in the past, but no longer. Markets barely blinked at Wednesday's news that NiceHash, a cloud-based crypto mining firm, had been hacked for, according to CoinDesk, more than $60 million.

Secondly, the surge in the price of the crypto-currency has nothing to do with its real-world adoption, despite the mountains of propaganda from evangelists arguing that Bitcoin is the future of money.

The largest online gaming shop in the U.S. and Europe, Steam, said Bitcoin had become "untenable" as a method of payment because of its volatility and transaction fees that can be as much as $20. That sounds a lot like Bitcoin becoming less useful as a method of payment, rather than the reverse. Yet, again, it doesn't seem to matter.

Thirdly, that this is an illiquid market where there are only buyers — for now, at least. One trader reports that orders for hundreds of Bitcoin are being executed in a matter of minutes, even at these eye-popping price levels.

But what would a really big Bitcoin sell order look like? The Bitcoin Investment Trust, which offers funds the chance to profit from the cryptocurrency's price moves without directly holding it, is one clue. It lost 25 percent of its value in a few hours on Tuesday, when there was no comparable move on Bitcoin itself. The stock still hasn't fully recovered.

If the push to launch Bitcoin futures is still-born, or strangled at birth by Wall Street, that could spook traders buying today in the hope of a more liquid market tomorrow.

Talk of fundamental value is beyond parody at this point. Everyone is throwing around bombastic price targets, from $40,000, to $400,000, to more than $1 million. If people want to buy something whose supply is structurally and speculatively capped, whether by rules or by people who hoard most of what they collect, then you can expect all sorts of prices in future. But if the herd panics and sells, prepare for pain.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Nov 06 2017

Wall Street Learns to Dance Bitcoin’s Tune

Wall Street was never supposed to get Bitcoin. Financial institutions are the bogeymen of virtual currencies, starting with the original Bitcoin white paper that outlined a payment method designed to bypass banks. The yin of crypto anonymity runs counter to the yang of financial regulations tracking clients and combating fraud. Just ask virtual currency firms with whom they bank.

Yet here we are. As the currency soars to a record, financial firms' attitudes are softening. On Tuesday, CME Group Inc. said it will start a Bitcoin futures contract. Goldman Sachs Group Inc. is reportedly weighing a trading desk for virtual currencies, while Morgan Stanley's CEO says Bitcoin isn't inherently bad and more than just a fad. At a time when big investment banks are finding regular financial markets hard going, as Gadfly's Stephen Gandel has noted, Bitcoin seems to offer old-school, volatile thrills. Or, as one expert describes it: "Capitalism distilled."

There are many sound reasons to resist this siren crypto call. A crypto desk would likely have to hold Bitcoin to protect its clients and hedge its trades, which means direct exposure to a volatile and risky asset that has experienced big price shocks in the past. And hackers would no doubt redouble their efforts to breach the broker's cyber-defenses. Extra reward comes with extra need for risk management, cyber-security and compliance. Higher operational risk looks likely.

A firm like Goldman or Morgan Stanley would also surely offer a lightning rod for regulators' concerns about crypto-currencies. So far, supervisors seem to have no real answer to the Bitcoin boom beyond waiting to see where it goes. It's hard to define virtual currencies and it's hard to regulate them, but banks are a different story. A regulated bank would have to protect clients, quantify the risk of losses and hold provisions accordingly. Adapting to anti-fraud rules also seems tough, as reported crypto bank account closures attest.

But absent a sudden market shock in crypto-land, the lure of greed and fear is getting harder to resist. Banks are living in competitive times. Hedge-fund clients are said to be pushing brokers to start dealing Bitcoin, and the risk of a rival getting there first rises with every new price record.

This year has seen 84 crypto hedge funds open their doors; there's already a fund-of-funds on the way; there's a federally regulated virtual currency options exchange.

Given the CME's latest move, at what point does a Bitcoin trading desk seem like a no-brainer? Assuming a market share equal to 5 percent of volumes traded in Bitcoin, Ethereum and Ripple, and fees charged at 20 basis points, a crypto desk could rake in $75 million of revenue a year, according to Greenwich Associates. That's equivalent to about 5 percent of Goldman's quarterly fixed-income revenue.

All this is redolent of former Citigroup boss Chuck Prince's words on the eve of the financial crisis: "As long as the music is playing, you've got to get up and dance." Bitcoin is a dance every bit as manic as the famous market bubbles and panics tracked by Charles Kindleberger. But Wall Street trading desks are being told to get up and start swaying. If Goldman won't do it, someone else will.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Oct 10 2017

Japanese Megabanks’ Tight Spot

No joy at home, and little more abroad.

That’s the situation facing Japan’s megabanks, which have bet big expanding overseas only to find gains elusive. At the same time, they’re not benefiting from the pickup in household lending domestically. Prime Minister Shinzo Abe’s decision to call a snap election for later this month and the likelihood negative interest rates, introduced in early 2016 to encourage spending, will persist won’t improve matters.

Thanks to those low interest rates, domestic loans, particularly mortgages, are accelerating. But that business is mainly going to the nation’s regional banks, who cater more to households.

What’s even more worrying is that international operations, supposedly a savior of businesses coping with unfortunate local demographics, are also hurting. In the year ended March, overseas net interest margins fell at Mitsubishi UFJ Financial Group Inc., Sumitomo Mitsui Financial Group Inc. and Mizuho Financial Group Inc. The latter two also posted even lower overseas net interest margins than at home, Fitch Ratings Ltd. noted. Offshore advances, hurt by higher funding costs, grew in the single digits and will continue to do so, according to director Naoki Morimura.

There are two reasons for the decline. First, banks in the international markets where the trio have been operating are becoming more defensive about defending their own turf. And second, U.S. regulations are increasing the cost of short-term funding such as commercial paper, forcing the megabanks to rely on more expensive pools like customer deposits and longer maturity bonds. The three financial institutions are also trying to keep risk-weighted assets under control, and are therefore more cautious about any rapid increase in overseas loans.

There are some positives. Mitsubishi UFJ has completed a few buybacks and, according to CLSA analyst Makoto Kuroda, Sumitomo Mitsui may be next to reward investors, since it has sufficient capital. And in the first quarter ended June 30, all three made money selling stock they held in other Japanese companies. With authorities pushing to unwind the country’s prevalent cross-shareholdings to improve corporate behavior, more such transactions could be in the works.

Fintech is another potential bright spot. Japan’s large lenders are investigating setting up digital currencies as China’s Alipay, owned by Jack Ma’s Ant Financial, enters a market where cash is still king. Analysts say Japan’s banks are especially keen to have their own digital currencies during the 2020 Olympic Games in Tokyo, when thousands of visitors from mainland China will be using Alipay. A consortium led by Mizuho and Japan Post Bank Co. is working on J Coin, an electronic currency that can be used on cellphones, while Mitsubishi UFJ is developing a blockchain-based alternative called MUFG Coin.

But none of that may be enough to improve the here and now for Japan’s big banks. With appetite from corporates for capital expenditure modest at best and persistent downward pressure on net interest margins, investors won’t have to try too hard to find a happier place to be.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.