Bitcoin's Milkshake Volatility Is Bringing Too Many Boys To The Yard

Central banks will have to reckon with Bitcoin, and that will suck.
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There’s no question that a lot of what you’re seeing in the cryptocurrency space is a combination of stupidity and pure, unadulterated speculation.

The list of anecdotes that supports that contention gets longer everyday and recently grew to include a story about someone’s actual grandmother obsessively checking the price of Bitcoin “while playing poker at a casino in her hometown of Las Vegas.”

That said, there’s still a sizable contingent of crypto crazies who insist their love for make-believe space tokens is at least partly attributable to an inherent disdain for central bank profligacy. Surely, they insist, persisting in policies aimed at debasing currencies will ultimately end in a hyperinflationary hellscape. Here’s how former derivatives trader Kevin Muir put it earlier this week:

Say what you want about the investing merits surrounding Bitcoin and all the other cryptocurrencies, but it’s safe to say that without the massive Central Bank science experiment of massive balance sheet expansion and negative rates, it would have been considerably more difficult for cryptocurrencies to reach this sort of popularity. Try blowing a cryptocurrency bubble with positive real rates. Tough. Try again with negative real rates throughout the world. Much easier.

The same central bank policies which have helped create demand for these alternative “stores of value” (and the scare quotes are there for a reason) have also served to inflate massive bubbles in financial assets and depress cross-asset volatility. Indeed, one of the only recent bubbles that isn’t completely dwarfed by the run-up in Bitcoin is the short vol. trade (yellow line):

Screen Shot 2017-12-13 at 3.22.11 PM

But here’s where this gets really amusing. Trading operations have suffered mightily as a consequence of suppressed cross-asset volatility and the “complacency” it entails. Just ask Wall Street, where trading revenues have come under tremendous pressure thanks in no small part to the persistence of the low vol. regime. In the same vein, turnover in hedge funds’ largest portfolio positions fell to 13% last quarter according to Goldman - that’s a new record low.

More than a few folks - myself included - have suggested that given the prevailing market conditions, it might be time for the pros to take the plunge into Bitcoin in an effort to find some volatility. As Barclays wrote last week ahead of the Cboe’s Bitcoin futures launch, “Bitcoin is 15-25x as volatile as the S&P 500, 20x-40x as volatile as gold, and even 5x-11x as volatile as oil as measured by the coefficient of variation.” Here’s the chart on that:

Screen Shot 2017-12-13 at 3.23.11 PM

Well on Wednesday, in a new piece called “In Bitcoin, Commodity Traders Try To Revive Heady Days,” WSJ details what certainly sounds like a frantic scramble by discouraged traders to grab a volatility lifeline in the crypto space. To wit:

With volatility and interest in commodities dwindling, some traders say they can’t afford to lose out on the bitcoin frenzy, even if the nascent market is rife with risks. With a finite number of bitcoins that can be created through “mining,” bitcoin isn’t exotic to commodities traders used to parsing supply and demand.

[...]

Typhon Capital Management, a hedge fund that invests in commodities, plans to launch several funds dedicated to cryptocurrencies in January. The funds, with strategies like passive investing, algorithmic trading and arbitraging price differences, will be led by George Michalopoulos, who managed the oil volatility portfolio at Citadel Investment Group until 2011.

“The interest has been staggering,” said James Koutoulas, chief executive of Typhon, citing inquiries from endowments, foundations, and family offices in the Middle East and Asia. “These are investors that won’t return calls for our excellent commodity-trading strategies. For crypto, they’re calling us.”

Ok, so for one thing, nobody would intentionally ignore phone calls if the “strategies” in question were actually “excellent.” That would be stupid, as it would amount to consciously avoiding outperformance in a world where every basis point counts.

But let’s give James a break here and assume everything he says is true. There are now endowments and foundations actively seeking out people to trade Bitcoin for them and apparently, everyone assumes that commodities traders are well suited for this endeavor.

Forgive me, but I’m not sure past performance in traditional commodities is a guarantee of future results in Bitcoin. If these swashbucklers thought commodities were exciting, just wait until they find themselves trading against someone’s Dewar’s-guzzling, chain-smoking grandma who’s placing orders on Coinbase while shrieking “hit me” to the blackjack dealer. Or against a Millennial who’s literally gambling his student loan disbursements on GDAX at 3 in the morning while doing a keg stand.

Coming full circle, the irony in all of this is that not only is central bank largesse giving the tinfoil hat hyperinflation crowd a justification for piling into cryptocurrencies, it’s also forcing professional traders to take the plunge by suppressing volatility across traditional assets.

The real punchline will come when the noxious mix of Bitcoin, septuagenarians, Millennials, Wall Street, and algos ends up triggering a crypto crash that spills over and drives up volatility in traditional assets, forcing central banks to step in and ease further, thus starting the whole thing over again.

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