Bitcoin Addendum: Running Out Of Oxygen; The 'Money Of The Internet' Fallacy; In Addition To Bitcoin Futures & Systemic Risk
December 23, 2017
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I genuinely can't resist a quick addendum to my recent bitcoin post. I thought I had said all that needed to hold upward said. But equally Bitcoin's toll has escalated to novel highs of nearly US$20,000, at that spot has been a commensurate ascension inwards the grade of folly too fuzzy thinking, too I can't seem to maintain my thoughts on the affair to myself. I guide hold 3 additional points/observations to make:
#1 The provide of fresh oxygen looks to hold upward nearing its limits
I commented before this calendar month that ii out of the peak 10 Wall Street Journal stories were on Bitcoin (or cryptocurrencies generally) - upward from exactly an occasional article 6-12 months ago. Well, yesterday, 3 of the peak ix stories were on cryptocurrencies (and predominantly Bitcoin), too everyone - too I do hateful everyone - is at 1 time talking nearly Bitcoin. If nosotros are non already at the top, nosotros must hold upward damn close unopen (temporally; a terminal euphoric spike is ever a possibility). I volition hold upward really suprised if the cryptomania does non peak out inwards early 2018, if non sooner.
The betoken to consider hither is that whatever asset is going to guide hold a natural storey of daily selling reflecting some little fraction of its aggregate marketplace value. Some minority of the holders of an asset volition create upward one's heed to sell on whatever given solar daytime for a multifariousness of reasons. These may include the involve for money for personal reasons, or because they create upward one's heed to bring some profits or rebalance their portfolio, etc. Liquidity inwards the housing marketplace plant inwards a similar way - at that spot volition ever hold upward some natural storey of selling from the liquidation of estates; people moving or moving overseas, etc.
The marketplace capitalisation of all Bitcoin was lately approaching US$400bn, too let's assume for the sake of declaration that the average natural storey of selling is 25% of the total issuance each twelvemonth (i.e. the total Bitcoin stock turns over nearly 1 time every 4 years - an assumed asset menstruum probable substantially inwards excess of the actual average). That way that US$100bn of novel buyers guide hold to hold upward establish every year, or US$274m a day. Let's circular it to US$300m a day.
That US$300m way that if the average novel buyer purchases say US$1,000 of Bitcoin, that 300,000 novel buyers suckers involve to hold upward establish every unmarried calendar solar daytime to absorb the flow of natural selling exactly for the toll to non give-up the ghost down. For the toll to rise, an fifty-fifty greater storey of buying involve occur. And equally the toll rises, the aggregate dollar value of this steady flow of natural selling correspondingly increases. For instance, if Bitcoin's toll was to double again, 600,000 novel daily buyers of US$1,000 worth of Bitcoin would involve to hold upward establish inwards monastic tell for the toll to non fall, too so forth.
This is what it way for a bubble to eventually collapse nether its ain weight. As the toll rises, the discover of novel buyers needed continues to rapidly rise, whereas the discover of potential untapped buyers continues to shrink (because yous increasingly achieve a betoken where most people that are willing too able to purchase the asset guide hold already purchased it). When an inflection betoken is reached, where the follow of natural selling begins to transcend the stride of influx of novel buyers, the toll volition start to fall, too when it does, marketplace psychology also changes, causing buyers to interruption too the stride of selling to increase, equally greed rapidly turns into fear.
Whether nosotros guide hold reached or are nearly to achieve this inflection betoken with Bitcoin remains to hold upward seen, but I wouldn't hold upward at all surprised if nosotros had. Everyone is talking nearly it too it is all over the media, too prices guide hold lately gone parabolic, which guide hold all historically been reliable reverse indicators that propose that the stride of novel buyer influx is probable at or to a greater extent than or less its high. Bitcoin is nearly equally to a greater extent than or less a textbook bubble yous volition ever find, too such bubbles almost never destination good for the longs.
#2 Money for the meshing fallacy
A recent media article on the 'Bitcoin Billionaire' Winklevoss twins quoted them equally maxim that Bitcoin was the start money "built for the internet". Commenting on the slow, cumbersome, too costly physical care for involved with traditional international money transfers intermediated past times conventional banks, they noted:
"The joke is if yous desire to larn money from New York to London on a Fri night, give-up the ghost to JFK, bound on a bird with a pocketbook of cash too you'll larn at that spot quicker than when yous genuinely wire. [Bitcoin] is the start money that's built for the internet".
With this comment, the Winklevoss twins are doing fiddling to a greater extent than than demonstrating their profound naivety too ignorance nearly how the fiscal organisation works. The considerable delays oftentimes associated with international money transfers guide hold fiddling to do with applied scientific discipline or the limitations of our existing currencies, but instead reverberate the pregnant regulatory too compliance burdens banks operate under, including the involve to comply with mandated primal banking concern processes for dealing inwards unusual telephone commutation markets. And governments never movement quickly. There are also checks too balances inwards house to preclude fraud too errors, which are of import when large sums of money are involved.
Banks are dependent area to all kinds of onerous regulations, including the necessity to undertake extensive KYC (know your customer) due diligence, too monitor transactions to assist detect, written report on, too preclude money laundering, terrorist financing, too fraud, alongside other things. In addition, many primal banks tightly monitor too regulate unusual telephone commutation marketplace activity, due to the systemic importance of telephone commutation charge per unit of measurement volatility, too unusual currency transactions inwards many countries require considerable paperwork to comply with stipulated primal banking concern procedures too difficult too soft currency controls. And these actions involve to hold upward co-ordinated across boarders with banks operating nether unlike regulatory regimes. It is these regulatory factors that are the elbow grease of delays, too they guide hold zilch to do with existing currencies beingness less 'digitally enabled' than their crypto counterparts.
For a to a greater extent than realistic flavour, consider the next exerpt from a recent article discussing why Malaysia's primal banking concern lately banned all deposits too withdrawals from Bitcoin wallets until dealers furnished the CB with increased information too transactional transparency. The article noted:
"Among the information needed past times the primal banking concern [before bitcoin wallets are allowed to operate again] are the discover of transactions, including the conversion from digital currency to fiat money too vice versa equally good equally conversion from digital currency to another; the value of the transactions; meshing purchase too sell position; work of transactions, payment method too the discover of client accounts."
The argue transactions are dull is because banks are obligated to encounter all these obligations. If they were non dependent area to these restrictions, transaction speeds would hold upward much faster too to a greater extent than frictionless. Indeed, that is already the example for many regular transactions. For instance, regular ATM cash withdrawals; the processing of little debit too credit carte du jour transactions; e-money transactions; too online or mobile domestic money transfers, are all extremely fast, reliable, depression cost, too secure - indeed much faster, much cheaper, much to a greater extent than reliable, too much to a greater extent than secure too fraud-free, than cryptocurrencies, which are an inferior solution (this is before discussing the considerable job of the lack of security too hackability of Bitcoin wallets - US$70m worth of coins was stolen exactly over a calendar week ago; if yous thought yous held the coins, tough luck).
The bulls may endeavour to struggle that the whole attraction of Bitcoin is that it is unregulated too distributed inwards nature too thus bypasses the involve for all this regulatory too compliance burden. But again, it is naïve inwards the extreme to assume that regulators volition willingly allow their powers of monetary too fiscal organisation management to hold upward usurped, or hold upward powerless to intervene to preclude that outcome. In my opinion, at that spot is simply no way regulators too primal banks are going to allow unmonitored too unregulated transactions to occur inwards scale via cryptocurrencies, too equally nosotros saw inwards Malaysia this week, if they wishing to intervene to preclude that from occurring, it is a uncomplicated exercise to ban all banks from accepting deposits or withdrawals from bitcoin wallets forthwith, rendering the so-called currencies unusable inwards the said solid soil overnight.
More of this regulatory clampdown tin give notice hold upward expected to occur over fourth dimension if cryptocurrencies proceed to grow. In the past times they were mere curiosities, but that volition modify if they grow too give-up the ghost to a greater extent than systemically important. Furthermore, from the perspective of modern monetary management, they are highly flawed constructs - their putative express provide too rising value are inherently deflationary inwards nature, too hence anathema to modern primal banking (be careful what yous wishing for - a highly deflationary currency volition crash the economic scheme - a currency that piece of cake loses its value over fourth dimension is much to a greater extent than conductive to economical activity; the gilded touchstone failed miserably too was scrapped partly for this reason). Even if Bitcoin were a practiced thought inwards theory, inwards practise it volition never hold upward able to component equally the frictionless global currency the bulls promise it tin give notice too volition hold upward able to.
#2 Money for the meshing fallacy
A recent media article on the 'Bitcoin Billionaire' Winklevoss twins quoted them equally maxim that Bitcoin was the start money "built for the internet". Commenting on the slow, cumbersome, too costly physical care for involved with traditional international money transfers intermediated past times conventional banks, they noted:
"The joke is if yous desire to larn money from New York to London on a Fri night, give-up the ghost to JFK, bound on a bird with a pocketbook of cash too you'll larn at that spot quicker than when yous genuinely wire. [Bitcoin] is the start money that's built for the internet".
With this comment, the Winklevoss twins are doing fiddling to a greater extent than than demonstrating their profound naivety too ignorance nearly how the fiscal organisation works. The considerable delays oftentimes associated with international money transfers guide hold fiddling to do with applied scientific discipline or the limitations of our existing currencies, but instead reverberate the pregnant regulatory too compliance burdens banks operate under, including the involve to comply with mandated primal banking concern processes for dealing inwards unusual telephone commutation markets. And governments never movement quickly. There are also checks too balances inwards house to preclude fraud too errors, which are of import when large sums of money are involved.
Banks are dependent area to all kinds of onerous regulations, including the necessity to undertake extensive KYC (know your customer) due diligence, too monitor transactions to assist detect, written report on, too preclude money laundering, terrorist financing, too fraud, alongside other things. In addition, many primal banks tightly monitor too regulate unusual telephone commutation marketplace activity, due to the systemic importance of telephone commutation charge per unit of measurement volatility, too unusual currency transactions inwards many countries require considerable paperwork to comply with stipulated primal banking concern procedures too difficult too soft currency controls. And these actions involve to hold upward co-ordinated across boarders with banks operating nether unlike regulatory regimes. It is these regulatory factors that are the elbow grease of delays, too they guide hold zilch to do with existing currencies beingness less 'digitally enabled' than their crypto counterparts.
For a to a greater extent than realistic flavour, consider the next exerpt from a recent article discussing why Malaysia's primal banking concern lately banned all deposits too withdrawals from Bitcoin wallets until dealers furnished the CB with increased information too transactional transparency. The article noted:
"Among the information needed past times the primal banking concern [before bitcoin wallets are allowed to operate again] are the discover of transactions, including the conversion from digital currency to fiat money too vice versa equally good equally conversion from digital currency to another; the value of the transactions; meshing purchase too sell position; work of transactions, payment method too the discover of client accounts."
The argue transactions are dull is because banks are obligated to encounter all these obligations. If they were non dependent area to these restrictions, transaction speeds would hold upward much faster too to a greater extent than frictionless. Indeed, that is already the example for many regular transactions. For instance, regular ATM cash withdrawals; the processing of little debit too credit carte du jour transactions; e-money transactions; too online or mobile domestic money transfers, are all extremely fast, reliable, depression cost, too secure - indeed much faster, much cheaper, much to a greater extent than reliable, too much to a greater extent than secure too fraud-free, than cryptocurrencies, which are an inferior solution (this is before discussing the considerable job of the lack of security too hackability of Bitcoin wallets - US$70m worth of coins was stolen exactly over a calendar week ago; if yous thought yous held the coins, tough luck).
The bulls may endeavour to struggle that the whole attraction of Bitcoin is that it is unregulated too distributed inwards nature too thus bypasses the involve for all this regulatory too compliance burden. But again, it is naïve inwards the extreme to assume that regulators volition willingly allow their powers of monetary too fiscal organisation management to hold upward usurped, or hold upward powerless to intervene to preclude that outcome. In my opinion, at that spot is simply no way regulators too primal banks are going to allow unmonitored too unregulated transactions to occur inwards scale via cryptocurrencies, too equally nosotros saw inwards Malaysia this week, if they wishing to intervene to preclude that from occurring, it is a uncomplicated exercise to ban all banks from accepting deposits or withdrawals from bitcoin wallets forthwith, rendering the so-called currencies unusable inwards the said solid soil overnight.
More of this regulatory clampdown tin give notice hold upward expected to occur over fourth dimension if cryptocurrencies proceed to grow. In the past times they were mere curiosities, but that volition modify if they grow too give-up the ghost to a greater extent than systemically important. Furthermore, from the perspective of modern monetary management, they are highly flawed constructs - their putative express provide too rising value are inherently deflationary inwards nature, too hence anathema to modern primal banking (be careful what yous wishing for - a highly deflationary currency volition crash the economic scheme - a currency that piece of cake loses its value over fourth dimension is much to a greater extent than conductive to economical activity; the gilded touchstone failed miserably too was scrapped partly for this reason). Even if Bitcoin were a practiced thought inwards theory, inwards practise it volition never hold upward able to component equally the frictionless global currency the bulls promise it tin give notice too volition hold upward able to.
#3 Bitcoin futures brand their debut, potentially ushering inwards growing systemic risks
To much fanfare, both the CME too the CBOE guide hold lately launched Bitcoin futures products, too several investment banks/brokers guide hold noted that they volition allow their clients to merchandise them. The bulls watch this equally a sign that Bitcoin has at 1 time started to give-up the ghost mainstream, too the apparent postage stamp of blessing shown past times major traditional fiscal manufacture players is seen equally proof of Bitcoin's growing legitimacy.
I know plenty nearly the fiscal manufacture - having observed it over many years, too having worked for an investment banking concern inwards a past times life for over a decade - to know that their willingness to merchandise Bitcoin-related fiscal products says zilch to a greater extent than than that they think at that spot are fees to hold upward made trading these products inwards the brusque to medium term. At best, they volition hold upward agnostic on the coin's investment merits; at worst they volition fully aspect the digital currencies to eventually give-up the ghost to zero, but promise to brand money trading the products inwards the interim.
The argue futures products guide hold popped upward is simply that Bitcoin has at 1 time grown to a size where its total marketplace capitalisation is approaching US$400bn, such that the trading of fiscal products related to this novel 'asset class' is at 1 time a major revenue generation opportunity. However, that absolutely should non hold upward viewed equally providing whatever sort of assurance of Bitcoin's legitimacy. The banks volition brand too maintain their trading income fifty-fifty if Bitcoin eventually implodes. Indeed, historically, the fiscal manufacture is far from having covered itself inwards glory through the exercise of restraint inwards choosing to forego brusque term fee opportunities due to the long term fiscal risks they entail.
Furthermore, spell many watch the arrival of Bitcoin futures as, equally worst, a curiosity, I genuinely watch something a lot to a greater extent than sinister too worrisome. Bitcoin is non similar most fiscal products against which derivative products are traded, inwards that most underlying instruments similar commodities or stock indexes, guide hold intrinsic value too an inherent bound on the realistic grade of volatility the underlying musical instrument is probable to experience. However, equally I discussed inwards my prior post, Bitcoin has the realistic run a jeopardy of seeing trading completely seize upward too the 'currency' essentially give-up the ghost to null overnight, too this is a run a jeopardy that seems to hold upward poorly understood past times most marketplace participants, who instead appear eager to liken it to whatever other financially-tradable production or 'asset class'.
Furthermore, spell many watch the arrival of Bitcoin futures as, equally worst, a curiosity, I genuinely watch something a lot to a greater extent than sinister too worrisome. Bitcoin is non similar most fiscal products against which derivative products are traded, inwards that most underlying instruments similar commodities or stock indexes, guide hold intrinsic value too an inherent bound on the realistic grade of volatility the underlying musical instrument is probable to experience. However, equally I discussed inwards my prior post, Bitcoin has the realistic run a jeopardy of seeing trading completely seize upward too the 'currency' essentially give-up the ghost to null overnight, too this is a run a jeopardy that seems to hold upward poorly understood past times most marketplace participants, who instead appear eager to liken it to whatever other financially-tradable production or 'asset class'.
This was non such a large bargain when Bitcoin was a relatively little cash-settled curiosity. If yous were long Bitcoin too it all of a abrupt collapsed to zero, it would hurt, but its failure would non guide hold systemic consequences. However, if Bitcoin futures products grow to whatever appreciable size, this volition change, because all of a abrupt large amounts of Bitcoin futures contracts trading on margin could sense a dramatic modify inwards value, too the amount of underlying margin could bear witness woefully inadequate. We saw the consequences of this inwards the Global Financial Crisis, when large derivative bets against the turn down inwards the value of tranches of mortgage bonds imploded, bankrupting several institutions such equally AIG.
Counterparties at to the lowest degree guide hold recognised the elevated run a jeopardy of outsized volatility past times offering a maximum of 50% margin (vs. allowing equally much equally 96% margin on daily positions inwards conventional currencies too commodities). However, if the amount of outstanding notional Bitcoin futures were to grow to a cloth size of say 1x the underlying instrument, or US$400bn, on an average margin of 50%, upward to US$200bn of fiscal organisation uppercase could hold upward at run a jeopardy - plenty to guide hold systemic consequences - too worse still, competitive pressures may also erode the size of this security margin equally well. If the coins were to all of a abrupt too unexpectedly give-up the ghost to zero, this could mitt of import leveraged fiscal marketplace counterparties serious, life-threatening losses on defaulted futures contracts that its customers were unable to settle. That could hold upward potentially destabilising to the fiscal manufacture (Buffett, allow it hold upward recalled, famously described derivatives equally fiscal weapons of volume destruction).
My broker (and the primary custodian on an upcoming fund I am launching), Interactive Brokers, for instance, is offering Bitcoin futures. A few years ago, IB lost to a greater extent than than US$100m after the Swiss Franc was unexpectedly allowed to sharply appreciate past times the Swiss primal bank. It rose nearly 20% inwards a day, which resulted inwards many futures contracts having inadequate cash collateral to settle, too defaulting. IB has some US$5bn inwards uppercase so was comfortably able to absorb the hit, but it does highlight the risks posed to counterparties offering access to leveraged derivatives products when an musical instrument experiences an unanticipated too outsized grade of volatility.
For now, the amount of outstanding Bitcoin futures issuance is small, too so nosotros involve non worry - especially if the bubble is already cresting highs too nearly to imminently implode. However, if the bubble keeps inflating too the grade of outstanding notional Bitcoin futures increases, too contest betwixt providers drives downward the storey of required margin, so nosotros volition involve to hold upward really careful, because unfortunately, the rails tape of the fiscal manufacture of foregoing a brusque term fee generating chance inwards monastic tell to guard against longer term systemic risks is non encouraging, too the manufacture has a long rails tape of successfully inventing novel ways to bankrupt itself.
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