Get ready for the biggest short squeezes of all times – Bitcoin

It seems pretty obvious to me that talking about Bitcoin as the “biggest short of all times” is only going to end up as one way – the biggest short squeeze ever known in the history of mankind before finally busting down on a slow journey to nearly zero.

I think the last time this happened was when the Hunt brothers were partially successful in cornering the silver futures market, before they lost control and it all collapsed underneath.

Another great example was when Porsche nailed short sellers of Volkswagen stock in 2008 by accumulating a hidden option to acquire 75% of the company, with the German state owning 20% – leaving precious little for short sellers to cover with.

The real issue here is marginability of Bitcoin futures – it doesn’t even matter if margin rates are 35% or 100%, if Bitcoins trade from $10k to $100k in a three-day period, we will start to see FXCM-type action in the brokerage sector and derivative clearing, just as the chairman of Interactive Brokers promised.

Once the short interest in bitcoin futures starts to rise, it is like adding gasoline to a six tonne pile of gunpowder and expecting everything to be all right while lighting up a cigarette next to it. Good luck.

This is starting to make gold look increasingly like a good bet.

Just for full disclosure, I’ve known about Bitcoin since it was under a dollar a coin, and clearly I was taken aback at how it has morphed into present day. I’ve been outright incorrect regarding pricing predictions.

Further disclosure: Have not owned, nor do I intend to take any positions on bitcoins, which is the closest thing one can get to legalized gambling.

Bitcoin valuation review

Here is a chart of milli-Bitcoins to US dollars over the past month:


Anybody having bitcoins over the past month has seen a 1/3rd drop in their US-denominated equity. (As a side note, investors in precious metal gold would have seen a 5% drop in the same time period).

However, the gist of this post is that Bitcoins has long since moved away from the “novelty” factor where people would speculate on them just on the basis of being collectibles (think of Beanie Babies in the late 90’s) and now the market is pricing in true economic worth of Bitcoins – in this case, it is far, far less than what it has been trading for.

Companies and entities that are collecting bitcoins for payment (!) inevitably have to liquidate them or they will continue to face currency risk in transactions.

In addition, it is perfectly obvious at this point that using bitcoins as a currency medium for illicit (silk road, etc.) transactions is just inviting the relevant authorities to digitally track the transactions and make the appropriate associations with the wallets to the identities of the people holding such wallets – the illicit marketeers might as well be writing paper cheques to each other. These illegal trades likely constituted a high amount of the initial bitcoin traffic but this has now ceased.

The only transactions I would see at this point that are economically viable for the medium are currency transactions to avert low denominations of capital controls in countries that are constrained by such measures (think of examples like Argentina, Venezuela and most African dictatorships). I do not see this being particularly viable considering the liquidity of bitcoin markets is nowhere close to institutional levels. In addition, such transactions are indeed illegal in their host countries!

There are structural issues with bitcoin that will continue to hamper its viability, of which I have addressed in earlier posts on this site.

One is that as the blockchain gets bigger and computational difficulty rises, it will become more incumbent upon large digital processors to maintain the transactions. I have already written about the well-known 51% risk where somebody with sufficient computational power over the rest of the network can subvert transactions and simply ruin it for the other 49%. In addition, computational difficulty of Bitcoin continues to increase to levels where it makes no sense except for industrial data-center levels of computational power to operate Bitcoin networks. Ironically, this is not what was envisioned by the pioneers of Bitcoin, which preferred a much more decentralized mechanism to arbitrate the transactions. Instead, concentration will be leading to an obvious state of the union where the 51% owner to the network will be, in effect, the central bank.

Large scale data centers such as have pledged to keep under 40%, but why kill your golden goose so prematurely by scaring away dumb money from coming into the marketplace?

There are also more and more other digital currency schemes (Litecoin, Dogecoin, etc.) which continue to trade, but are simply there just to be an alternative to bitcoin – most of the mindshare out there is on bitcoin compared to the alternative currencies. However, with all of these new digital currencies, there are always incumbent advantages – the group establishing the coins will have all the advantages of mining them first, and then with the hopeful attempt to build a marketplace for it so they can just dump it for real currency. Bitcoin has some inherent advantage than other digital currencies simply because the implementation of this was relatively “innocent” compared to most crypto-currencies being created today that are simply there to steal money from other gullible people.

There is the casino-type element of currency trading. I continue to read the Reddit thread and continue to see people with less financial knowledge give out wisdom on Bitcoin. I would be very curious to know the total amount of bitcoin float out there that is simply being held for speculative (i.e. nothing other than for the reason they believe others will believe it is going up) purposes. Now we are reading threads like this or like this, both of which remind me of Canadians that said “I have shares in Nortel purchased at $80, what do I do?”.

Finally, there is the risk that the cryptographic features of Bitcoin that make it very difficult to access other people’s wallets, may be cracked. While this is unlikely, if such a discovery were to be made, it would clearly cause a collapse in the entire Bitcoin system. The only analogy I could make to this in the central banking fiat currency system is having other people being given access to your own bank account at any time without any reversibility (although you can go and find their wallet and spend it right back if you know the algorithm to doing so!). The system would simply collapse.

I can’t see any reason why any Canadian would want to purchase Bitcoins at this time other than for the novelty factor. If you’re planning on buying currency to prepare for the end of the world (whether it be war, hyperinflation or alien abductions), I would not buy something that depended upon a reliable electrical connection, let alone internet connectivity!

Liquidating Bitcoins is not easy!

People should have seen this a mile away, but MtGox (the exchange that at one point facilitated the vast majority of Bitcoin transactions for real currency) finally packed it in and documents claimed that there was a gaping hole of about 744,408 Bitcoins due to some technical issues with the exchange software that accumulated over a couple years (not to mention a net of about US$33 million cash owed to customers!).

My hypothesis is more plausible: fraud. Anybody running an exchange operation like this would be looking at their account balances like a hawk, hourly, and have proper built-in mechanisms to ensure that there are no leaks in the system. Claiming a loss like this over a period of a couple years is simply incomprehensible.

One of the great things about how Bitcoin works is that the entire transaction ledger (the blockchain) is in public view, and some enterprising people will likely be able to reconcile what happened from publicly available data. 744,000 Bitcoins is about 6% of the entire amount in circulation.

Considering the underlying value of Bitcoin is zero, it is still amazing to see that one can still sell these things for US$500 a piece on other exchanges. This is assuming, of course, they won’t go under either.

I didn’t know how high the hype would go for Bitcoin. Guessing when the tops of markets occur is a tricky endeavour and is simply that, guesswork. My initial guess was “no higher than US$10,000 per bitcoin”, but I subsequently revised that to closer to US$900 than the $10,000 mark.

Now I’ll come with an even starker prediction: Bitcoins will never reach its all-time high (US$1,200) ever again. The hype is gone and the true weaknesses of Bitcoin have more or less been shown to make the entire system unusable except as a novelty.

Bitcoins to currency almost reminds me of what gift cards are to currency: like cash, except worse. If you truly want to invest in something that is relatively immune to the machinations of evil central bankers world-wide, this is the chart of the commodity that I think has profited the most from Bitcoin’s collapse:


Right now a bitcoin is US$516 on Bitstamp (the now leading exchange for Bitcoin volume). You can get an ounce of gold for 2.6 bitcoins. An easy decision for those that still want to believe in hyper-inflationary theories.

Disclosure: No bitcoins, no gold!

When will Bitcoins peak? Part 2

My first article went through some scenarios of when Bitcoins will peak in price. I gave a very broad order-of-magnitude prediction of “not higher than US$10,000/Bitcoin”, but I’m now going to revise this to a peak price closer to present trading prices (roughly US$900/coin) than the upper threshold (US$10,000).

The reason is quite simple: Apparently some Ukranian firm has managed to obtain a majority of the computational power of the network. Blockchain dominance was one of the reasons why I thought this scheme would collapse.

A deviant entity will want to lay low in the shadows and be patient while others continue to pour money in the scheme, but the cartel’s inevitable goal is to vacuum as much capital out of the system as possible. There is no point in announcing to the world you are taking over the whole monetary system, but rather to wait in stealth and just wait for people that are generally unaware of this political dynamic to put their hard currency into it.

It is akin to playing in a marketplace with a central banker, which functionally takes the “independent” nature of Bitcoin out of the equation – if the Ukranian entity wants to pull the plug on the network by denying your transactions, they can.

Why bother when you have a real-world currency market to dabble around with? At least you can pay income taxes in the host currency, while in Bitcoins, you have nothing.

A binary phrasing of this is: Do you want your central bank to be controlled by a Ukranian corporation, or an arm of your national government?

Bitcoins as alternative currency

You can read about Bitcoins on its own site, but summarizing the story, some computer engineers developed a currency that rely on peer-to-peer networking to conduct exchanges and also to generate new currency (which has a hard-coded limit to creation). Your ability to generate currency is directly a proportion of how much CPU power you can generate to solve a mathematical problem. With a typical personal computer, your ability to do this is quite limited. However, people with more powerful hardware (in particular, advanced graphic cards) are able to solve these problems.

What I am finding relatively amusing is that this marketplace has an active following with people actively trading bitcoins for cash and vice versa. Over the past year, the market for this product has increased significantly, with about US$500,000 traded yesterday alone:

A currency is only as good as the confidence that people have in it. In this case, they believe a currency that can be minted only by some algorithmic work is something that inspires confidence because the rate of currency generation is relatively pre-defined. In light of this, it is not that different than any other currency. Gold-backed currencies have confidence because they can be exchanged for bits of yellow metal. Some countries can mine the yellow metal better than others. Canadian (paper) currency is valuable because it can be exchanged to pay governments taxes (fundamentally, this is the only true value the Canadian dollar has).

There is also the issue of “counterfeiting”, even if the bitcoin system is technically secure. One problem is that you can create an identical digital currency and call it something different. So in this essence, counterfeiting is a very relevant concern – not direct counterfeiting, but copy-catting. Bitcoin does have a “first mover advantage” which may mitigate against this.

My last point is that generating CPU cycles is not “free” – not only do you have to keep your computer on to doing so, but the watts required to power your processor is higher when it isn’t idle. There is an interesting article about a person in Mission, British Columbia (a suburb of Vancouver, BC), getting raided by the RCMP because his power consumption was typical to that of a marijuana grow-operation. Instead, he was mining for Bitcoins. As people hit the “Bitcoin lottery” and receive a block of 50 bitcoins, this can be liquidated in the marketplace for approximately US$800-900 – not a bad haul for an expenditure of electricity.

The debate here should not be whether Bitcoins are useful as a currency or not, but the lesson here is strictly one in economics – people see value in very strange things, and when people do see value, there will be markets created. In this case, the product is a currency that is only valuable because of its rarity and difficulty of generation, and is not too different than trading artwork or collectibles which have similar appeal.

I would like to thank Alfred Pang, a personal friend, for pointing out Bitcoin to me many months ago. You may wish to purchase his 99 cent e-book, 100 Things to Do the Day After You Are Fired, for amusement. (I do not receive any remuneration for this link whatsoever). If you don’t feel like paying cash, this also works out to about 0.058 bitcoins (which can be sent to Bitcoin address 1B3brvhfMZVS3sRgJaSUijrT9FMyhhVoAB).