If Jay Gould were alive today, he would've traded bitcoin.
Perhaps the most blatant hypocrisy perpetrated by bitcoin evangelists
is their insistence that bitcoin and other digital currencies represent
a return to a truly democratic financial system beyond the control of
banks and other special interests, where players small and large can earn
enormous profits simply by HODLing.
Of course, this idealistic take couldn’t be further from the truth. As
Bloomberg points out, the markets for bitcoin and most of its cryptocurrency
clones more closely resemble the US equity market of the Gilded Age, where
a handful of powerful traders and brokers colluded to move prices in their
favor. And because securities laws at the time were virtually nonexistent,
the big players minted suckers with impunity.
According to Bloomberg, about 1,000 so-called “whales” control 40% of
the bitcoin in circulation, giving them unrivaled leverage over the broader
market. And because there are no laws explicitly banning collusion in
digital currency markets, only the most blatant pump-and-dump operations
risk being prosecuted as fraud.
And with the price skyrocketing like it has in recent days, the incentive
for these traders to begin taking profits has never been more pressing.
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.
As Bloomberg explained, the manipulation in bitcoin is extreme because
many of the big players know each other from having been involved in the
digital currency space since its infancy. Add to this the fact that the
risks are incredibly asymmetrical there’s tremendous upside in terms
of profits if they can successfully pull it off. And the chances of them
drawing the scrutiny of law enforcement are relatively low.
“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.
Case in point: Some of these so-called whales admitted in an interview
with Bloomberg that they regularly incorporate what would in the equity
market be considered material nonpublic information into their trading
strategies.
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.
And investors who buy into smaller tokens are at an even greater disadvantage.
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.
Unsurprisingly, Bloomberg managed to find someone to defend the status
quo: Whales won’t dump their holdings, this person argued, because they
“have faith in the long-term potential of the coins.” This strikes us
as a naïve assumption.
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.
While the concentrated holdings of the modern bitcoin market should give
potential investors pause, in some ways, it's not all that different from
the modern equity market. As we pointed out back in September, the Bank
of Japan owns a staggering 75% of the domestic ETF market. Increasingly,
equity ownership in the US and around the world is becoming increasingly
concentrated in the hands of central banks, sovereign wealth funds and
the largest asset managers like BlackRock, Fidelity and Vanguard.
While the whales can exercise unrivaled influence over the price of bitcoin,
they aren't the only players in the bitcoin market with a natural inclination
toward self-dealing. As Bill Blaine pointed out, nearly every bank knows
bitcoin's extraordinary gains are a crowd delusion fuelled by the extraordinary
promise of free wealth.
Yet, many will be willing to trade and settle them for their clients
largely retail. So, while the bitcoin bubble has (for now) blessed hundreds
of thousands of mom and pop investors with spectacular returns, these
gains will only continue as long as the cartel allows them too.
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