Digital Currencies Have a Wild September
I mused back in May about whether bitcoin was in a bubble or not.
But surely, Bitcoin must be in a bubble? One bitcoin is now worth over $2,000! And the value of all digital currencies is over $70,000,000,000!
Hahahaha. That sentiment seems so … quaint? Bitcoin, despite crashing over 30% after reaching a high of around $5,000, is currently trading at $4,161. And I do mean “currently,” as I originally wrote $3,600 when I started writing this article last week. By the time you will be reading this, it is entirely plausible that it is below $3,000 or above $5,000. Just bitcoin has a market cap of $70 billion and all cryptocurrencies together are worth over $120 billion!
The pop to $2,000, which caused everyone to start calling bitcoin a bubble again, came shortly after China had cracked down on its own exchanges for not charging fees to trade.
The yuan accounted for 98 percent of bitcoin trading in the past six months, data from bitcoinity.org show — though this is inflated by the fact that Chinese exchanges, unlike most others, do not charge a transaction fee, said Bobby Lee, chief executive officer of BTCC, the most active exchange in the past month.
It turned out that most of the Chinese volume was fake and created by insiders who wanted to pump up volumes to make the exchanges appear to have more liquidity than they actually did. Once exchanges in China were forced to charge a fee for every trade, volumes plummeted. The currency took a brief tumble below $1,000 on greater fears that the Chinese government would take further steps to crackdown on cryptocurrencies. However, the market quickly adjusted, and bitcoin quintupled in price only six months later. U.S. exchanges, which had already been subject to a stricter regulatory regime, were the primary beneficiaries.
It turns out though that the Chinese government was just getting started. Earlier this month, the People’s Bank of China (the “PBoC,” the Chinese central bank) banned Initial Coin Offerings (“ICOs”). ICOs are a fascinating new mechanism for startups to raise capital through the blockchain. Whereas a venture capitalist will only provide money in exchange for equity ownership, an ICO allows founders to sell virtual tokens in exchange for, well, not much. These tokens could theoretically represent ownership in a company, but the SEC has determined such ICOs would be subject to U.S. securities law.
Furthermore, who wants to give away equity if they do not have too. More often than not, ICOs sell a virtual coin, which represents some kind of pre-sold service that may or may not ever come to market. You can think of most of these ICOs like a Kickstarter. In Kickstarter, investors typically help fund the production of a physical good. In an ICO, investors help fund the development of a blockchain application. In exchange for participation in either a Kickstarter or ICO, the investor gets early access, discounts, and/or the feeling of having helped bring a cool product to market.
There are now hundreds of ICOs a week. Most of these are pre-sold services like distributed file storage (which was able to raise $200M+ in 60 minutes). There are also silly uses like a share in the Wu-Tang album (Link: whitepaper) that pharma-bro Martin Shkreli owns. The ICO market has gone bananas, which of course you can buy a coin for.
With bitcoin’s soaring valuation, there is a lot of excess wealth held by people who made it almost literally overnight. To many it is all just paper wealth. Throwing a few thousand here and a ten thousand there into ICOs has become popular. ICO participation soared, recently surpassing VC funding. ICOs are really just whitepapers though with little auditing. There is no VC to do due diligence. This was especially true in China, where a lot of scams cropped up.
Investing in ICOs turned out to be a good investment though. Many of the virtual coins, which are even tradable on exchanges, have soared in value. So, of course the PBoC took away the punch bowl:
China’s ban on initial coin offerings (ICO) is a necessary move to stop illegal fundraising and pyramid schemes but should not stop firms from studying blockchain technology, a senior central bank official told the Financial News newspaper on Tuesday.
The PBoC was not done with just banning ICOs though. A week later, China shut down bitcoin trading altogether:
China’s two largest remaining bitcoin exchanges, Huobi and OKCoin, announced today they would halt trading services for local customers by Oct 31. This followed a similar notice yesterday from BTCC, another major exchange, about a halt in local trading by the end of this month. The latest service closures will effectively put an end to the yuan-bitcoin exchange markets, once the world’s largest driver of bitcoin trading volume.
It was actually shocking that China did not shut down their crypto exchanges much earlier. China has done everything possible to control currency flows. That the ability to move wealth out of the country through digital coins continued for so long was surprising. Bitcoin and ethereum took a significant hit. They have recently recovered but are still about 20% off their all-time highs.
Jamie Dimon also decided to go after Bitcoin at a conference:
JPMorgan Chase CEO Jamie Dimon took a shot at bitcoin, saying the cryptocurrency “is a fraud.” “It’s just not a real thing, eventually it will be closed,” Dimon said Tuesday at the Delivering Alpha conference presented by CNBC and Institutional Investor.
Jamie’s deputy also piled on, saying “another worrying aspect of cryptocurrencies are some parallels to fraudulent pyramid schemes.”
I am usually a fan of Jamie, but here I think he is wrong. Far from being a fad or a fraud, digital currencies have become a very real thing. I am not sure that $4,000 is the appropriate level for bitcoin, but the days of cryptocurrencies being a niche interest of libertarians and computer science nerds are long gone. And not all bank CEOs agree with Jamie either. James Gorman of Morgan Stanley said that it was “certainly something more than just a fad” to clients at an industry conference.
Dimon’s own clients are embracing cryptocurrencies in their portfolios. One of the things that struck me in recent discussions with lots of hedge funds and proprietary trading firms, is just how many have some kind of digital currency effort. This is a big change from just June when I lamented the lack of institutional bitcoin trading.
A good example of this is the recent move by Chase Lochmiller who left Jump (one of the largest HFT firms) to join a crypto-hedge fund. Chase is one of the better prop traders I have known in my career.
But in July Lochmiller left his job at Jump Trading, where court documents show he made millions of dollars annually, abandoning his career of using quantitative models to trade stocks and futures in fractions of a second, in order to pursue cryptocurrency investing. At 31, Lochmiller joined Polychain Capital … that has seen its assets surge from $4 million to $250 million in less than a year of trading cryptocurrencies like ethereum and tezos.
Jump Trading is suing him because they too have a digital currency trading initiative!
Furthermore, the digital currency ecosystem has flourished. The underlying technology, the blockchain, has unleashed the talents of tens of thousands of developers working to solve really boring problems (e.g., clearing and settlement) in new and interesting ways. The wealth generated from bitcoin and ethereum are being plowed into all kinds of interesting projects like decentralized exchanges. I hope to spend some more time on this ecosystem, and its application to Wall Street, in a future newsletter.
Thanks largely to China, September was a transformative month for digital currencies, and they have managed to adjust well. The fact that these currencies are still standing after all kinds of regulatory pressure makes me feel like the markets are much more robust then anyone gave them credit for. It makes me still excited to be a participant in the space.
