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Correction Hypothesis for Events Realized on January 16, 2018
The contemporary appreciation of Bitcoin’s assigned value draws comparison to the past neurotic cravings for tulip bulbs, over-levered internet companies, and East Asian real-estate. Even less equanimous has been its relatively distant flash crashes and recent “corrections”, the latter occurring frequently and having been terminologically exaggerated; boding of their reactionary domain. These sell-offs are in magnitude, although in obviously smaller notional amounts, analogous to the supply-side movements of the Great Depression, CDO divestitures, and the OPEC turmoil on oil futures markets.
However, from January 15, 2018 till January 17, 2018, the price of Bitcoin tumbled approximately 36% when paired to the U.S. dollar. One such explanation for Bitcoin’s recent price correction may lie in potentially shrewd price manipulations on behalf of hedge funds with ample capital to participate in the stratospherically ecclesiastic, ecstatic, and apprehensive Bitcoin marketplace. Utilizing a market neutral strategy, these funds may have corralled an opportunity to profit from the soft information, marketed information, and misinformation that new and consequently overextended or extra-levered investors have used to base their trading decisions. Here’s how.
The spot price of Bitcoin on December 10 was approximately at $15,000 when Chicago’s derivative exchanges, CME (NASDAQ:CME) and CBOE (NASDAQ:CBOE), opened Bitcoin futures trading for the first time at 5PM local time. Some funds may have engaged in, say, 1,000 contracts set for expiry on January 17, 2018. The notional amount of the underlying, when made, would have been around $75,000,000 or 5,000 BTC. Specifically, these investors would bet along the “short” side of the contract. This means that they would agree to pay back their “long” side counterpart the amount equal to 5,000 BTC at the contracts’ date of expiration-there is no cyber assignment of Bitcoin. However, from an institutional perspective, the cryptocurrency market is extremely speculative and seldom easy to convince oneself or clientele of a purely directional move, for BTC by the most ephemeral contracts’ expiration date on January 17 of 2018 could presumably be marked up or down a magnitude of 10.
In order to mitigate the risk that accompanies being on the short side of a BTC futures contract, managers would purchase the same amount of BTC as the underlying 5000 XBT or BTCF8 futures contracts, roughly at around the same price. Therefore, in the event of continued BTC parabolic growth, those short may cover their positions and preclude the potential suffering of holding outright futures or realizing a naked position. However, to the fund manager, there shouldn’t exist the scanty hopes of “not losing” in a market of retail investor madness. Before contract expiration, he/she may sell his “cover” amount of 5000 BTC at current market price (Jan. 16). Such a large order would incite “FUD” (Fear, Uncertainty, and Doubt), trigger stop-loss orders, and rash sells from individual investors. By the time of contract expiry, the price of BTC may be a margin of what it was when one engaged in its derivatives at $15,000. One could then profit off of such a drawdown by buying back the same quantity of Bitcoin, closing out the contract, and realizing a gain in the difference between the price from when one sold the 5000 BTC near contract expiry and the price bought back but precisely after it reflected the effects of a flash sale.
Market Propagation: Value Considerations
Intrinsic value is the inherent value a cumulative assessment of both the tangible and intangible assets assigned to a “thing” by a marketplace or assaying body. Extrinsic value is the value methodically, or less so in lightly charted markets, affected by exogenous factors. The price of an option OTM (Out of the Money) relies on extrinsic valuation. Its price is reliant on historical volatility, time decay, mark-to-market pricing (exempt from any motivation but bid-ask spread market efficiency), and is determined through options pricing models, notably, the Black-Scholes Model. There is no intrinsic value to a given coin, but if it’s backing technology develops traction, it’s relative price may develop an appreciating assigned value.
Speculation, unpunished greed, and naivte are the substrata of high volatility from which Bitcoin needs to remain buoyant through confirming speculation towards future affixed use-value. Those purchasing Bitcoin are plainly speculating a rise in its price because they see its potential once larger markets price it in. This effect may lead to the consequential Gresham’s Law which states that elements of greater intrinsic value will be kept (hoarded) to either appreciate or maintain relative value favor. Bitcoin’s technology and prospective implementation contains intrinsic value through properties of decentralization, immutability, and transparency. This means that the accretion of value is circuitous. Buyers hoard, and whilst they hoard, there is more of a demand for more hoarding as hoarding the future “good” medium of exchange (Bitcoin) will maintain one’s wealth more than the “bad” money (fiat, other mediums of exchange). This hoarding is forward looking as buyers are satisfied with containing a unit of account and a store of value that may provide excellent solutions in the future. Bitcoin’s intrinsic value has been belayed to this belief. It is currently, the value that the market has assigned to Bitcoin.
“Liquidity Traps” and Gresham’s Law
Liquidity traps are largely macroeconomic phenomena. They occur, according to Keynesian economists, whence economic actors nullify the potential effects of the central bank’s intention to stimulate interest rates by increasing the nominal money supply. The result of which, plays generally to and fro with Gresham’s law. If consumers rather deposit money into saving or checking accounts out of speculation of a bond bear market that would become compounded by the intentional stimulus towards higher interest rates, such monetary policy renders ineffective; bond certificates, “bad” money, proliferates the ask book and M1 monetary aggregates, “good” money, becomes hoarded.
Bitcoin doesn’t have a central authority. But the term “liquidity trap” may be contextualized to our situation. Those with capital to move the Bitcoin market, called “whales”, may initiate several injections that will perform exactly what adopting a short side of multiple future contracts does: moving the market and stimulating the currency in similar ways to how the Federal Reserve increased MBS exposures and engages in reverse repos. Concerning Bitcoin’s susceptibility to “whale” manipulation, and both the generous portions of profit and traps that have seen Bitcoin’s price go in different directions in hyperbolic fashion, prospective institutional suitors of Bitcoin will think twice and then some now.
The correction has also served to accentuate the beady eyes and profuse sweatiness of retail investors in Bitcoin markets. The appropriation of Gresham’s law may not be as sound of a theory or as applicable now to Bitcoin as it’s candlestick’s have reflected in its growth in 2017. There isn’t a Bitcoin “investor confidence” gauge, apart from the frenetic claims of Bitcoin-related crypto-pundits, programmers, opportunists, cryptographers, and marketers idealistically masquerading around Twitter, however corrections staged coincidentally near January XTB or BTCF8 contracts’ expiration date has proven to be a useful event for prognosticating trading sentiment towards conspicuously large sell walls.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.