The Bitcoin Whales: 1,000 People Who Own 40 Percent of the Market (Bitcoin Bubble?)

ILLUSTRATION: PATRIK MOLLWING FOR BLOOMBERG BUSINESSWEEK

On Nov. 12, someone moved almost 25,000 bitcoins, worth about $159 million at the time, to an online exchange. The news soon rippled through online forums, with bitcoin traders arguing about whether it meant the owner was about to sell the digital currency.

Holders of large amounts of bitcoin are often known as whales. And they’re becoming a worry for investors. They can send prices plummeting by selling even a portion of their holdings. And those sales are more probable now that the cryptocurrency is up nearly twelvefold from the beginning of the year.
 
About 40 percent of bitcoin is held by perhaps 1,000 users; at current prices, each may want to sell about half of his or her holdings, says Aaron Brown, former managing director and head of financial markets research at AQR Capital Management. (Brown is a contributor to the Bloomberg Prophets online column.) What’s more, the whales can coordinate their moves or preview them to a select few. Many of the large owners have known one another for years and stuck by bitcoin through the early days when it was derided, and they can potentially band together to tank or prop up the market.
 

“I think there are a few hundred guys,” says Kyle Samani, managing partner at Multicoin Capital. “They all probably can call each other, and they probably have.” One reason to think so: At least some kinds of information sharing are legal, says Gary Ross, a securities lawyer at Ross & Shulga. Because bitcoin is a digital currency and not a security, he says, there’s no prohibition against a trade in which a group agrees to buy enough to push the price up and then cashes out in minutes.

Regulators have been slow to catch up with cryptocurrency trading, so many of the rules are still murky. If traders not only pushed the price up but also went online to spread rumors, that might count as fraud. Bittrex, a digital currency exchange, recently wrote to its users warning that their accounts could be suspended if they banded together into “pump groups” aimed at manipulating prices. The law might also be different for other digital coins. Depending on the details of how they are structured and how investors expect to make money from them, some may count as currencies, according to the U.S. Securities and Exchange Commission.

Asked about whether large holders could move in concert, Roger Ver, a well-known early bitcoin investor, said in an email: “I suspect that is likely true, and people should be able to do whatever they want with their own money. I’ve personally never had time for things like that though.”

“As in any asset class, large individual holders and large institutional holders can and do collude to manipulate price,” Ari Paul, co-founder of BlockTower Capital and a former portfolio manager of the University of Chicago endowment, wrote in an electronic message. “In cryptocurrency, such manipulation is extreme because of the youth of these markets and the speculative nature of the assets.”

The recent rise in its price is difficult to explain because bitcoin has no intrinsic value. Launched in 2009 with a white paper written under a pseudonym, it’s a form of digital payment maintained by an independent network of computers on the internet‚ using cryptography to verify transactions. Its most fervent believers say it could displace banks and even traditional money, but it’s only worth what someone will trade for it, making it prey to big shifts in sentiment.

Like most hedge fund managers specializing in cryptocurrencies, Samani constantly tracks trading activity of addresses known to belong to the biggest investors in the coins he holds. (Although bitcoin transactions are designed to be anonymous, each one is associated with a coded address that can be seen by anyone.) When he sees activity, Samani immediately calls the likely sellers and can often get information on motivations behind their sales and their trading plans, he says. Some funds end up buying one another’s holdings directly, without going into the open market, to avoid affecting the currency’s price. “Investors are generally more forthcoming with other investors,” Samani says. “We all kind of know who one another are, and we all help each other out and share notes. We all just want to make money.” Ross says gathering intelligence is legal.

Ordinary investors, of course, don’t have the cachet required to get a multimillionaire to take their call. While they can track addresses with large holdings online and start heated discussions of market moves on Reddit forums, they’re ultimately in the dark on the whales’ plans and motives. “There’s no transparency to speak of in this market,” says Martin Mushkin, a lawyer who focuses on bitcoin. “In the securities business, everything that’s material has to be disclosed. In the virtual currency world, it’s very difficult to figure out what’s going on.”

Ordinary investors are at an even greater disadvantage in smaller digital currencies and tokens. Among the coins people invest in, bitcoin has the least concentrated ownership, says Spencer Bogart, managing director and head of research at Blockchain Capital. The top 100 bitcoin addresses control 17.3 percent of all the issued currency, according to Alex Sunnarborg, co-founder of crypto hedge fund Tetras Capital. With ether, a rival to bitcoin, the top 100 addresses control 40 percent of the supply, and with coins such as Gnosis, Qtum, and Storj, top holders control more than 90 percent. Many large owners are part of the teams running these projects.

Some argue this is no different than what happens in more established markets. “A good comparison is to early stage equity,” BlockTower’s Paul wrote. “Similar to those equity deals, often the founders and a handful of investors will own the majority of the asset.” Other investors say the whales won’t dump their holdings, because they have faith in the long-term potential of the coins. “I believe that it’s common sense that these whales that own so much bitcoin and bitcoin cash, they don’t want to destroy either one,” says Sebastian Kinsman, who lives in Prague and trades coins. But as prices go through the roof, that calculation might change. 

BOTTOM LINE – It’s not necessarily illegal for big holders of some cryptocurrencies to discuss trading with one another. That puts small buyers at a disadvantage.

Bitcoin actually broke through the 17,000 barrier yesterday before retreating and is now back to 14,500 area.
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Bitcoin has no intrinsic value? And that makes it different than the US Dollar, how?
Here is the Elizabeth Warren commemorative $5 Dollar bill.
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Trumpcoin? Bitcoin Reaches $15,600 Mark (Up From $710 On 2016 Election Day of Trump)

Crypto-currency  Bitcoin has experienced a tremendous run-up since the 2016 election (November 8th) of Donald Trump. In fact, it has risen from $710 on election day 2016 to $15,600 as of today.

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The US Treasury 10 year yield rose dramatically on election day 2016, but today’s 10-year yield is about the same as it was in late November 2016.

The US Treasury 10Y-2Y curve continues to flatten as Trump enthusiasm waines as Democrats ferociously attempt to block almost any change proposed by Trump or Republicans.

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Oddly, Bitcoin was left off the list off the Financial Systems Vulnerabilities Monitor.

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Robot Monster! Transportation Stocks, Bitcoin Zoom, Tech Stocks Stutter and Hindenburg Omen Keeps Flashing

Another day in the land of Central Bank bubbles.

According to Bloomberg, transportation stocks have rallied more than 8 percent in a week, realigning them with industrials at new highs in a coupling that is one of the market’s oldest bullish technical indicators. According to the century-old Dow Theory, simultaneous records in the groups trigger a buy signal for U.S. stocks. Optimism that changes in U.S. tax policy will benefit the industry reignited the Dow Jones Transportation Average on Monday, pushing it back to an all-time high along with the industrials gauge.

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But at the same time, the Hindenburg Omen keeps … omening?

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The tech stock index SOX is stuttering.

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And crypto-currency Bitcoin keeps bubbling.

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Yes, another day in the land of Central Bank-generated asset bubbles.

“There is no escape from us, fool humans. There is no escape!”

Janet Yellen and The FOMC creating asset bubbles. Here is a video of her last speech to Congress.

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Whalen: Banks and the Fed’s Duration Trap (The Perils Of Fed QE and Low Rate Policies For Ten Years)

As we approach final exams at George Mason University School of Business, I thought this summary of how The Fed is impacting both Treasury and Agency MBS risk (duration) would be appropriate. A great summary of the topics we have discussed in class are provided by my friend Chris Whalen.

Chris Whalen (Institutional Risk Analyst): Is a conundrum worse than a dilemma? 

One of the more important and least discussed factors affecting the financial markets is how the policies of the Federal Open Market Committee have affected the dynamic between interest rates and asset prices.  The Yellen Put, as we discussed in our last post for The Institutional Risk Analyst, has distorted asset prices in many different markets, but it has also changed how markets are behaving even as the FOMC attempts to normalize policy.

One of the largest asset classes impacted by “quantitative easing” is the world of housing finance.  Both the $10 trillion of residential mortgages and the “too be announced” or TBA market for hedging future interest rate risk rank among the largest asset classes in the world after US Treasury debt. Normally, when interest rates start to rise, investors and lenders hedge their rate exposure to mortgages and mortgage-backed securities (MBS) by selling Treasury paper and fixed rate swaps, thereby pushing bond yields higher.

An essay on this very subject was published by Malz, Schaumburg et al in a blog post for the Federal Reserve Bank of New York in March 2014 (“Convexity Event Risks in a Rising Interest Rate Environment”).  Since then, the size of the Fed’s portfolio has grown a bit, and volatility has dropped steadily. The key characteristic to note is that the Fed owns most of the recent vintage, lower coupon MBS that would normally be hedged by private investors and banks. For those of you who follow our work, this argument tracks that of our colleague Alan Boyce, who has long warned about the hidden duration risk in the bond market since the start of QE.  The FRBNY post summarizes the situation nicely:

“When interest rates increase, the price of an MBS tends to fall at an increasing rate and much faster than a comparable Treasury security due to duration extension, a feature known as the negative convexity of MBS. Managing the interest rate risk exposure of MBS relative to Treasury securities requires dynamic hedging to maintain a desired exposure of the position to movements in yields, as the duration of the MBS changes with changes in the yield curve. This practice is known as duration hedging. The amount and required frequency of hedging depends on the degree of convexity of the MBS, the volatility of rates, and investors’ objectives and risk tolerances.”    

Since the Fed and other sovereign holders of MBS do not hedge their positions against duration risk, the selling pressure that would normally push up yields on mortgage paper and longer-dated Treasury bonds has been muted.  Thus the Treasury yield curve is flattening as the FOMC pushes short-term rates higher because longer-dated Treasury paper, interest rate swaps or TBA contracts are not being sold, either in terms of cash sales by the FOMC or hedging activity.  Chart 1 shows 2s to 10s in the Treasury bond market from FRED.

Source: FRED 

More, the volatility normally associated with a rising interest rate environment has also been constrained because the Fed’s $4 trillion plus portfolio of Treasuries and MBS is entirely passive.  As the FOMC ends purchases of Treasuries and MBS, and indeed begin to sell down the portfolio, presumably the need to hedge by private investors and financial institutions will push long-term rates up and with it volatility.  As Malz notes, “the biggest change [between 2005 and 2013] is the increase in Federal Reserve holdings, partly offset by a large reduction in the actively hedged GSE portfolio.”  Yet since the modest selloff in 2013, volatility in the Treasury market has continued to fall.

While it is clear that some smart people at the FRBNY understand the duration dilemma, it is not clear that the Fed staff in Washington and particularly the members of the Board of Governors get the joke.  Unless you believe that the FOMC is intentionally pursuing a flat yield curve as a matter of policy, it seems reasonable to assume that the folks in Washington do not understand that reducing the size of the System portfolio is a necessary condition for normalizing the price of credit.

George Selgin at Cato Institute wrote an important post this week talking about Chair Janet Yellen’s defense of paying interest on excess reserves (IOER) held by banks at the Fed (“Yellen’s Defense of Interest on Reserves”). Selgin’s analysis raises a couple of important issues.

The fact that Yellen and the FOMC will not manage IOER at or below the market rate for Fed Funds is quite telling, particularly since doing so would address many of the key criticisms of the policy. This suggests two things, first that there really is no “free” trading in Fed Funds anyway and the Fed is the market. Second that the FOMC somehow thinks that it must push higher the bottom of the band — this despite the huge net short duration position of the street and the $4 trillion passive Fed portfolio.

The more urgent question is Yellen’s view of a trade off between QE/open market operations and IOER that Selgin illustrates very nicely. The FOMC seems to think that merely not growing the portfolio or slowly selling is an option while they raise benchmark rates like IOER and Fed Funds. In fact, reducing the portfolio always was the first task, before changing benchmark rates. Especially if one is cognizant of current market conditions.

Unless the FOMC changes its approach to managing its $4 trillion securities portfolio, either through outright sales or active hedging, it seems likely that the Treasury yield curve will invert by Q1 ’18.  The Fed could sell the entire system portfolio and the street would probably still be short duration due to low rates and continued QE purchases by ECB, BOJ, etc. And to repeat once again, the agency mortgage securities market is down 30% on issuance YOY. Again, the FOMC does not seem to appreciate that the yield curve must invert, unless the bond trading desk at the FRBNY is actively selling and/or hedging all of the MBS and even longer dated Treasury paper.   

Some analysts such as Ed Hyman (Barron’s, “A Smooth Exit Seen for Mortgage Securities,” 11/20/17) believe that banks will increase purchases of agency paper as the Fed unwinds QE. We beg to differ.  Bank holdings of MBS as a percentage of total assets has barely moved in years.  But more to the point, one has to wonder if Yellen and other members of the FOMC appreciate the trap that has been created for holders of late vintage MBS.

 The Fed has suppressed both interest rates and volatility via QE, as shown in Chart 2 below:

Source: Bloomberg

As and when the balance between buyers and sellers in the MBS market slips into net supply, volatility will explode on the upside and the considerable duration extension risk hidden inside current coupon Fannie, Freddie and Ginnie Mae MBS could prove problematic for the banking industry. 

“The duration extension risk goes turbo if we see rates up, volatility up and a curve steepening,” notes Boyce.  Or as Malz noted succinctly in 2014:

“When interest rates increase, the price of an MBS tends to fall at an increasing rate and much faster than a comparable Treasury security due to duration extension, a feature known as the negative convexity of MBS. Managing the interest rate risk exposure of MBS relative to Treasury securities requires dynamic hedging to maintain a desired exposure of the position to movements in yields, as the duration of the MBS changes with changes in the yield curve. This practice is known as duration hedging. The amount and required frequency of hedging depends on the degree of convexity of the MBS, the volatility of rates, and investors’ objectives and risk tolerances.”

Let me add color to Whalen’s interesting article.

First, here is a chart of Fannie Mae 3.0% 30 year TBA OAS duration compared to the 10-year Treasury yield and Freddie’s 30-year mortgage survey rate. You get the general idea of what will happen to Agency MBS duration when rates really begin rising.

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Second, The Fed has suppressed Treasury volatility with its massive QE program along with the 10-year low Fed Funds policy.

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Third, The Fed’s super low interest rate policy has left investors in the perilous left-hand side of the bond/MBS price-to-yield curve.

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Fourth, The Fed finally began their long-anticipated balance sheet unwind this week, although it was barely noticeable (only 0.27). 

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Here is a video of The Fed trying to unwinds its $4.4 TRILLION balance sheet.

Let’s see what happens when The Fed starts unwinding for real instead of just raising the target rate.

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Good luck GMU finance students on your final exam! Just play Ten Years After “I’m Going Home” to calm your jangled nerves. 

Coincidentally, Fed Chair Janet Yellen is going home as soon as Powell is sworn in as Federal Reserve Chair.

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Bitcoin Bursts To 11,500 Then Back To 9,500 As Consumer Purchasing Power Continues To Weaken

Are crypo-currencies like Bitcoin the new gold … or potential de-facto US currency? OR is Bitcoin and related crypto-currencies (e.g., Ethereum) in an appalling bubble? That is, few actual investors driving the price over 11,000. Time will tell.

But what we do know is that Bitcoin has just breached the $11,000 barrier while consumer purchasing power of the US Dollar keeps declining.

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Ethereum is showing a similar meteoric rise.

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UPDATE: Like any bubble,  Bitcoin and Ethereum Classic have lost a little air after 9am highs.

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Of course, the creation of The Federal Reserve System in 1913 under President Woodrow Wilson helped to constantly devalue the US Dollar ever since.

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With the Franklin Roosevelt’s Executive Order of 1933 preventing the hoarding of gold (and the subsequent Richard Nixon unilateral cancellation of the direct international convertibility of the United States dollar to gold) …

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we haven’t had to listen to fiery speeches like William Jennings Bryan on July 9, 1896, at the Democratic National Convention in Chicago. The issue was whether to endorse the free coinage of silver at a ratio of silver to gold of 16 to 1.

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The way it was in the United States.

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Hey, now we have FIAT currency (not backed by any precious commodity like gold or silver).

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Digital Gold? Bitcoin Rebounds From Correction While US Dollar Weakens

Yes, the US Dollar is FIAT currency (not backed by a precious commodity like gold, silver or even iron pyrite).

Bitcoin, the largest crypto-currency, has more than recoverd from the “correction” last week. It has resumed its all-time high price This is happening as the US Dollar weakens.

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Here is Bitcoin relative to Gold. Check out their relative performance since September.

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Is it digital gold? Well, Bitcoin is an alternative to FIAT currency like the US greenback, the Euro and the Yen. The massive expansion of Central Bank balance sheets has certainly concerned investors.

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An example of an 1899 $5 silver certificate.

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