Crypto Corner: Week Summary 22 Feb 2021

data taken at 9:43 am 26/02/2021

The Bitcoin price lost nearly 20% of its value in a week, and nearly 22% from the all-time-high at $58,354. The correction was exacerbated by the severe number of derivative contract liquidations observed on Monday and Tuesday: almost $6bio worth of long future positions were liquidated.

There were very extreme leveraged positions running in February: the premium of the September future on Deribit was quoting around 14% as the borrow rate surged dramatically. Indeed, the annualised implied borrow rate from the futures market was close to 20%. Investors were borrowing Bitcoin aggressively to build their long positions, unreasonably accumulating toxic “fuel”. Eventually, the improving macroeconomic outlook (higher inflation) together with negative comments from Elon Musk (“BTC & ETH do seem high!”) and Janet Yellen (“extremely inefficient way of conducting transactions”) lit the fire, resulting in the worst weekly correction since March 8th, 2020!

Markets are still stunned by the extreme volatility of the main cryptocurrency. The few positive announcements this week, including Square’s $170mil additional BTC investment, did very little to ensure a swift recovery.

TradingView - In Blue: BTC/USD Binance price versus Deribit’s BTC September futures. The difference reached $8,000 when BTC/USD was quoting above $56,000.

There is no doubt that this correction is a healthy one, wiping out the hopes of many speculators, and leaving long time confident HODLErs quite indifferent. Despite Warren Buffet’s famously dismissive quotes on cryptocurrencies (you might have a favourite! :)), I recently re-discovered one of them that sounds like good advice for newcomers:

“The stock [‘replace with Bitcoin’] market is a device for transferring money from the impatient to the patient.”

I also agree with Warren Buffet when he said in 2002 that derivatives are “financial weapons of mass destruction”. And like many, I experienced their destructive power and toxic fallout in 2007 to 2011. The derivatives business is certainly a greedy one. Even though the indicators of greed are most often showing before our eyes, we just choose to ignore them.

For the next part of this article, let’s press the rewind button to the old time when Bitcoin was not a “market” but only a “currency”. And let’s try to be the devil’s advocates.

For many long-term HODLers, Bitcoin was and is still a symbol, figuratively and literally speaking. Literally, I am speaking of a time when the ₿ symbol was probably still confused with the Thai Baht (฿). It was just two letters “BC” before it became “BTC”, and later on the “XBT”, the ISO 4217 currency code used by Bitmex among others.

Bitcoin was certainly in the early years a currency for the people. Still today, it is faster and more convenient than peer-to-peer exchanges of dollar bills, meaning without any intermediary, no Visa or Mastercard. Describing “Bitcoin” as “Fast” can be surprising for the investment banker who deals with nanosecond orders, or even a day trader sending dozens of orders per second. But how unfair is this when you think that a retailer would wait for days before having her account credited with the FIAT proceeds of the sale, minus the various fees and cash reserves of course. What Bitcoin and cryptocurrencies are trying to achieve is fairness, the freedom to exchange, spend, give and take risks, as a community.

Over the years and probably for as long as investment banking exists, investment bankers did also create a community, a high-end one, with their own rules. By merging investment banks with retail banks in the 1990s (the Gramm–Leach–Bliley Act), they slowly imposed their rules on the larger public. Investment bankers took considerable risks, and then used the public and sometimes colluded with governments (e.g. Goldman Sachs and Greece) to hide or de-risk positions when things went sideways. The central banks ripped value out of cash to bail out investment banks, and of course explained that it was the only solution to save the public, their favourite “hostage”, from total anarchy. And this last explanation was 100% true… it was the only solution. The credit delusion took a hit. Most homeowners realised that they never really had a home, nor value in their cash deposit account. Warren Buffet bailed out Goldman Sachs in 2008 when he bought newly issued preferred shares, specifically designed for him. Warren Buffet almost changed the common rules, invested, and Goldman Sachs was safe to resume its activities… Governments and Central Banks changed their rules, bailed out the economy and saved the economy.

Changing the rules for Bitcoin requires the large majority of holders to agree. It is not a “deal” between a few select entities. It is a referendum. Some would say it is less flexible, others that it is reliable. But what is more concerning here is the Bitcoin derivatives market.

When we assess the market sophistication around Bitcoin: futures, options, decentralised flash loans (?!) even exotic derivatives (!), it is difficult to conclude that Bitcoin is heading in the right direction… Exotic derivatives are complex products I used to trade 15 years ago, and we indecently joked about the business as the only business where almost everyone will eventually lose: investment banks, clients and the entire economy. The only winners are probably the traders, brokers and middlemen who cashed out their large bonuses at the end of each bull market year…

Bitcoin could be unsuited for toxic or high leverage products because of its scarcity. It becomes a “currency” if and only if the community is confident that it can buy dinner one day for 0.001 BTCs and the same one again a few days later for exactly 0.001 BTCs. By adding more volatility, leveraged markets could be perverting Bitcoin’s capacity to become such a currency, or…. the shift from $ to ₿ for an everyday currency is simply an unstable and long process. This process would also involve an upgrade, and it is up to the community to enforce it.

Bitcoin was perfect in its application 10 years ago, for down-to-earth people happy to buy a pizza for 10,000 bitcoins with no regrets. And it could be again 10 or 20 years from now. Meanwhile, the layers of leverage that are piling up are posing a new risk to the main cryptocurrency. Furthermore, as the Bitcoin integration with institutions grows further, it is likely that the Bitcoin price would grow to new heights, pushed by these same institutions to justify their plan and their interest in the first cryptocurrency, “bailing out” the market at every downturn. Isn’t this the definition of a bubble?