How to bet against the bitcoin megabubble

http://finance.fortune.cnn.com/2013/12/05/betting-against-bitcoin-bubble/

by flavor8 • 13 years ago

88 69 13 years ago

finance.fortune.cnn.com

confluence2• 13 years ago

This is what I've found to happen with stocks. Being short is bloody expensive, the upside isn't that big (unless you're long some underpriced insurance) and everyone is basically against you, for ages. If shorting/going long had the same upside/downside you'd have a much saner world. But that ain't the world we live in, and guys who want to go short, like me, just go into straight cash and treasuries (because strong governments have guns/monopoly on taxes) to wait it out until prices to return to sane levels.

This leads to a curious selection bias where only the craziest are present in the market (the rabid masses I like to call them) and they bid up everything to insane levels, while the sane just sit it out. This leads to bubbles of much greater variance than if those who currently wait out bubbles could reasonably bet against global stupidity.

Instead, I'm sitting on tons of cash while equity is overvalued throughout the world, and blowhards are plowing their life savings into computational fiat (think about it).

We do live in quite the world, don't we?

To societal collapse and global failure.

brc• 13 years ago

The market can stay irrational longer than you can stay solvent.

I forget who said it, but it's a very accurate quote.

confluence2• 13 years ago

John Maynard Keynes.

adventured• 13 years ago

Puts solve the problem of the upside not being that great.

They introduce a total loss potential, but you also can't lose more money than you 'invest' into the put contract. They also obviously introduce a timing element, that is arguably the most difficult variable for amateurs - it not being enough to just be right that X will fall, but that it has to fall by enough by X date as well.

iSnow2• 13 years ago

FWIW, there's Predictious too: https://www.predictious.com/economics - they offer binary ETFs on the bitcoin price.

And 796.com offers a kind of bitcoin price futures that you can use to bet on falling prices - not outright shorting, but close enough.

patrickk2• 13 years ago

The problem with predictious is the same as the author identified unfortunately - the currency used is bitcoin, so if you're right and the price falls, you could still lose money.

I would love if one of the major european bookies (e.g. Betfair, Bet365, William Hill, Paddypower) would let you place bets on the price at a given time in the future, in your local currency like euros. Bet365 already let you do this in major currency pairs, as do other bookies:

http://imgur.com/vMnFhe9

notahacker• 13 years ago

As I pointed out in another thread yesterday, the problem is potentially even worse than just a price fall; if Bitcoin falls sharply enough (and/or governments wade in to restrict Bitcoin use) most of these startups with a Bitcoin-based business model won't survive to pay up.

I'd have thought the specialist financial spread betting firms would in theory be best-placed to be a trustworthy shorting option for Bitcoin bears.

notdrunkatall• 13 years ago

Damn, I had the idea to do something like this a couple of weeks ago. Figures.

salient3• 13 years ago

Wouldn't this ultimately help stabilize the price of Bitcoin, in part because perhaps Bitcoin bubbles wouldn't reach such tall heights anymore, if a lot more people can bet against them?

I think besides much bigger volume and liquidity (still the main reasons for stability), this is probably one of the reasons why other currencies are so stable, because there's a lot of back and forth between traders - rather than everyone buying and buying and buying, until it comes crashing down hard.

omellet• 13 years ago

Other currencies are stable because they're actively managed by central banks, there's huge liquidity, and the currencies aren't inherently deflationary. Bitcoin has none of these things going for it. It's not a currency, for the most part, it's an instrument for speculators.

laichzeit0• 13 years ago

I'm curious as to why you (and other people) call Bitcoin a "currency"?

Even on the frontpage of http://bitcoin.org/en/ it's defined as an "innovative payment network and a new kind of money" and the word currency doesn't appear anywhere.

Do you also consider a cellphone to be a "phone" in the traditional sense. Could phones browse the web, edit documents, take photos, check email, etc. 20 years ago?

skriticos23• 13 years ago

Other currencies are (mostly) stable because they have a stable demand. For example, demand for USD is not increasing to tenfold over a year randomly.

Bitcoin is a very young currency / commodity and needs to find some form of equilibrium first. This will be reached once all people who potentially want to use Bitcoin do. Until then, each influx of new users will require a price correction as the supply is fixed.

VMG• 13 years ago

Other currencies are stable because they're actively managed by central banks

Until they aren't

salient3• 13 years ago

I don't really buy that argument. Yes, central banks can print more money, but it's not like they can print 30 percent of the existing money within a year to compensate for the 30 percent rise in demand for the dollar. But again, I think huge volumes and the law of numbers play a big role here, because I don't think it's possible to see a 30 percent rise in dollar demand within a year anymore, while that's very possible with Bitcoin (for now).

skriticos23• 13 years ago

I don't think so for two reasons:

1. Bitcoins already underwent several corrections (last one only a few days ago). These small "crashes" later resulted in longer, more stable phases. These substantial downturns flush out most bubble activity. (Bubbles usually go up until they burst. Bitcoin is generally all over the place. Very un-bubble like. When a bubble crashes, it's pretty much done for. When Bitcoin crashes, it's two weeks of wild swings and then soften on a new baseline.)

2. Bitcoin is an erratically growing commodity / currency. If Bitcoin succeeds long-term, then it's hopelessly undervalued currently (just because of the limited supply). If not, it's not worth anything. Basically it has a high risk associated with it and no safety net or more traditional baseline measure you could work with. This inevitably results in erratic price swings no matter what you do. For instance, the current price is mostly due to China getting into the game. There are still many other countries that are not even on the playing field. No financial instrument could prepare you if the demand rises because another big interest wave comes (like India) and the price needs to find a new equilibrium a magnitude higher.

Considering that Bitcoin got a value increase of 24543% in the past 2 Years, it's course corrections are outright tame.

arethuza• 13 years ago

"When a bubble crashes, it's pretty much done for."

I don't remember the dot com crash being quite as dramatic as that - the NASDAQ peaked in March 2000 dropped down in May and regained about 50% of the losses by July before dropping and climbing to the July level again in October before really dropping.

Edit: Graphs of Bitcoin/USD remind me of the description of start-up business plans from Cryptonomicon "conveniently summarized by graphs that all seem to be exponential curves screaming heavenward". :-)

salient3• 13 years ago

I guess my point was that rather than have Bitcoin grow 3x within a month because of some big news, then crash to 2x of its height, and then grow back "slowly" to where it was within another 1-3 months, it could just grow more smoothly to begin with, and even if there were some big news in a row, there could be a lot of people betting against it and having it grow perhaps only 50 percent overall that month, and then another 50 percent the next month, or whatever.

Slower rises, and no (big) crashes.

Lazare2• 13 years ago

Standard economic theory says yes. Robert Shiller, for example, has noted that one factor that led to the housing bubble in the US is that it's quite hard to short housing.

So yes, in general, an increase in the ability to short a commodity will, ceteris paribus, result in an reduction in its propensity to form bubbles. On the other hand, bitcoins are a bit weird. The obvious uses for bitcoins are basically illegal drugs and evading currency controls, both of which open bitcoin up to significant legal and regulatory risks.

dllthomas• 13 years ago

The most obvious use for bitcoins is bitcoin transaction fees, which isn't entirely circular as we find more interesting ways to use the block chain.

gnaritas3• 13 years ago

The most obvious use of bitcoin is to enable peer to peer exchanges of currency without banks, that's its purpose. Setting up a website that accepts payments just became vastly easier without the need for PCI compliance or even SSL; that is huge. Digital cash. That it can be used nefariously is beside the point, so can cash.

Choronzon3• 13 years ago

Classical Market making is probably the safest way to profit from bitcoin as the spread is so damn high. Good luck finding a hedging instrument though.

Choronzon3• 13 years ago

http://www.amazon.co.uk/Option-Trading-Volatility-Strategies...

An excellent chapter about market making in here,however you would have to adjust it quite a bit for bitcoin.

throwaway_yy2Di• 13 years ago

If it's supposedly safe, highly profitable, and no one's doing it (spread's still crazy), something's very very wrong.

Choronzon3• 13 years ago

Slow transaction speeds leave you with inventory for way too long (the bane of market makers ) and as you have no correlated instruments you can't even hedge the inventory you have.

thatcherclay2• 13 years ago

Anyone know the ratio of speculative investing versus real goods/services transactions on bitcoin?

I ask because it would not surprise me if 90% of all transactions go to people buying/selling against other currencies, which just makes it a zero-sum speculative tool, and with immature market dynamics at that. Zero-sum because it does not pin itself to anything of external value - ie, consumers thinking the economy is going to do well, so they take a significant loan out (increasing demand for USD) to buy a house. Without a fundamental externality like that, I think bitcoin will always just be a novel gambling mechanism, and if we cannot figure out how to make it a legit market then a bad one at that.

zby• 13 years ago

With the eletricity costs of mining it can be actually negative-sum game.

oleganza2• 13 years ago

Comparing investment with "real transactions" is like comparing kilograms with decibels.

Anyone who holds bitcoins (you, merchant, or bitpay) is a speculative investor. Everyone has different time preference. Someone holds for short time, someone for long. But what ultimately gives Bitcoin any value is all hands willing to hold it right now, this very moment. Only "speculative investment" creates value which you can then transfer in a "real transaction". If you don't want to hold you BTC, you need a merchant, or someone else willing to hold it (yes, speculatively), so you can transfer it. Transfer only happens as a result of speculative desire to hold asset.

Same with dollars. You don't buy cars and houses, but keep some cash balance in a speculation that it'd be more useful this way some day in the future. It's called "reservation demand", and only it gives money value. Otherwise money is worthless pieces of paper (or bits).

thatcherclay2• 13 years ago

Yea, I agree with you. I am trying to make a different point though - there is reserve demand in both dollars and bitcoin, but if the bulk of the pricing set for bitcoin is by transactions founded in speculation (ie, not tied to a physical good or service), then it would seem there is a very limited ability to increase value in the system (aside from new users coming into the market). A currency like USD is different - you can easily and reliably exchange USD for goods and services which increase in value independent of the currency instrument itself. That, and the fact that you can amplify demand by introducing credit, creates a different dynamic, which is why I think the ratio of liquidity created by "speculative" investments versus transactions tied to something external is an interesting indicator.

iSnow2• 13 years ago

Hard facts about speculation/real world transactions are hard to come buy, but someone tried in 2012 (http://codinginmysleep.com/measuring-bitcoin-speculation/) and the blockchain-info guys made an upto-date chart:

https://blockchain.info/charts/tx-trade-ratio

dschiptsov• 13 years ago

I am really curious about how to bid against the event in the past.)

omarkatzen2• 13 years ago

Shorting Bitcoins would be a terrible idea. I hate Bitcoin, and expect it to eventually crash, but if you nakedly short something and it goes up in the meantime (which BTC could) you can get whacked with margin calls and lose money even if you're right. That happened to a lot of people who shorted the Nasdaq (at, say, 3000) and tech stocks in the '90s. They were right, but they still lost their shirts.

roc• 13 years ago

It's that old line that the market can remain irrational longer than you can remain liquid.

In betting against a bubble, you're not placing a bet that the underlying assets are over-valued. You're placing a bet that something will pop the bubble in the timeframe you can afford. Essentially, you're not betting against the bubble, you're betting on the pin.

omarkatzen2• 13 years ago

With put options, you're betting on a timeframe. You make a profit if the price drops below a certain level by expiration.

With naked shorting, you're betting on it not getting above a certain level (the level at which you face margin calls you can't meet). It could go up 10x tomorrow and kill you.

paulgb• 13 years ago

I expect bitcoin to crash as well, but I'm curious, why do you hate it? As much as the crypto-currency fans can be annoying, I'd rather see them get rich on speculation than see the credit industry keep its oligopoly on online consumer payments.

patio113• 13 years ago

Counterparty risk makes this an even worse option than buying bitcoin.

Consider many of the antecedent events which might cause bitcoin to implode. How many of them leave unregulated derivatives exchanges up and capable of receiving your "Assign 10,000 BTC puts at $100 to those people who are short them" notice then rounding up a million dollars of actual money to send to you?

I've unfortunately wasted non-trivial time thinking about this, since if it were as reliable as shorting Zynga, I'd be as long puts as my risk tolerance can take.

bdcs2• 13 years ago

You can always take out a bitcoin loan for a standard short. That has no counter-party risk (on your end). Also, Coinsetter is an US startup that will allow shorting and has a lower amount of counter-party risk, IMO.

tptacek• 13 years ago

What makes you think Coinsetter's counterparty risk is low?

dia80• 13 years ago

There can be no options since volatility is impossibly high.. lets take an example. You buy an $850 put with the spot price at $850 and it expiries in 6 months. 90 day realized volatility has been 130% annualized so the black-scholes formula says i have to charge you $300 usd for that option. You make money if BTC is $550 or below in 6 months. Your upside is $550 if it goes to 0 and down side is $300 usd. Still want to trade?

tedunangst4• 13 years ago

I suspect you could find people willing to sell that put for less than $300. If there's no action at $300, somebody will step in at $200, or $100, or $10. Remember that Bitcoin can only go up, so there's no risk. It's like free money, you just have to be willing to accept a little less free money than the rest of market to get yours.

hasker• 13 years ago

black-scholes also assumes the ability to dynamically, instantaneously hedge with very low transaction costs I recall. The market-maker has to charge even more to recover costs in this case since they cannot dynamically hedge and bid-offer tight nor is the market deep.

patio113• 13 years ago

My sketch of the math back when BTC was $1,000 was that BS had a 1 year put at a $100 strike valued at about a nickel. At that price, assuming availability in quantity and acceptable levels of risk caused by factors other than BTC being worth more than $100 in a year, I'd be buying.

tedunangst4• 13 years ago

You could sell dollar calls for BTC and cash that out immediately. Opens you up to larger potential losses, but at least this way you're the risky counterparty. :)

tedunangst4• 13 years ago

oops, too late to edit, but I realized you'd want to sell puts. Accidentally reversed too many parameters.

ericb• 13 years ago

I'm always interested in hearing your thought process. Any interest in a blog post?

Disclaimer: I am long and think that the asymmetrical nature of the possible payout makes bitcoin interesting as a "bet". I believe it is valuable because the use-cases it can deliver on make it a unique animal, so I would relate the it to the concept of going long on cars vs. horses.

minimax• 13 years ago

The conventional way of doing this is to require option sellers to post margin with the exchange. Bitcoin/USD futures and options contracts would have huge margin requirements.

muyuu• 13 years ago

Looks like a great way to get swiped out.

pla3rhat3r• 13 years ago

Great article.

I saw no reason to keep reading after "You bet. But it's an expensive trade. And even if you're right, you won't walk away with much, if anything."

I wish more articles would be more upfront so I wouldn't have to waste time reading them.

LogicalBorg• 13 years ago

Funny! Try skipping to the concluding sentence or paragraph. Or just reading the first sentence out of each paragraph. That's how I skim the long, boring stuff.

alexeisadeski32• 13 years ago

There isn't a BitCoin ETF yet??

prodigal_erik• 13 years ago

Storing and guarding gold is a pain in the ass. Transaction fees for tiny positions in the entire Russell 2000 index would be prohibitive. These are the kinds of things people use ETFs to buy. Why would I want to buy into an ETF that holds BTC rather than buying BTC myself, is it easier to write options or loan into short interest that way?

alexeisadeski32• 13 years ago

Why would I want to buy into an ETF that holds BTC rather than buying BTC myself, is it easier to write options or loan into short interest that way?

Yes it would be easier.

Also, it'd be much easier to grab a BTC ETF on e*trade than to deal with the BTC exchanges.

How to bet against the bitcoin megabubble

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