Bitcoin: The Poison Has Begun To Spread
Short-term Bullish Catalyst Has Played Out
Back in December I warned everyone about Tether. Tether printing has now stopped, possibly due to the fact that its parent companies Tether Limited and Bitfinex were subpoenaed, and Bitcoin (COIN, OTCQX:GBTC) has collapsed to as low as $6,100 from a high of almost $20,000.
When Bitcoin was cratering, two major consumer finance companies, Square (SQ) and Robinhood, showed strong support for Bitcoin, allowing new money to be brought in. As I discussed in my last article, I was appalled that the companies would shameless promote Bitcoin (not educate, but promote) to its young and uneducated users, creating new bagholders. While Robinhood has not fully implemented its cryptocurrency trading platform (currently in five states), Square has fully enabled cryptocurrency trading on its Cash App for almost all of its users. I had predicted that inflows from the user base of these two companies will have a positive short-term impact on price, and indeed, since the weekend that Square launched its cryptocurrency trading platform, Bitcoin has rallied from $8,000 to as high as $12,000; then soon after Robinhood completed its initial launch on February 22 nd, Bitcoin began its recovery from its lows.
Right now, the initial wave of inflows from Square seem to have petered out. As Robinhood’s crypotocurrency trading platform ramps up, there could be some additional upside in the short-term. For reference, my previous forecast was $13,200.
Economy’s Worst Nightmare
I had hoped that would be the end of it. Without additional inflows, all cryptocurrencies will find their final resting place at zero. However, recent news demonstrated that greed has no bounds. On February 26 th, it was reported that Goldman backed Circle would purchase cryptocurrency exchange Poloniex for $400 million. To understand how insane this is, GAIN Capital (GCAP), which handles trillions of dollars of volume every year, is only being valued at roughly $300 million. Guess, how much capital Poloniex handles? Zero, that’s right. ZERO.
Poloniex is a cryptocurrency only exchange, meaning that it does not receive any fiat funds and all of its “profits” are denominated in cryptocurrencies. It doesn’t shy away from Tether however.
Furthermore, while the Tether scheme is now public knowledge, it’s unclear if everyone knows that Poloniex (along with Bittrex) was one of the suspicious exchanges that are likely associated with Bitfinex (You can read my investigation here). It is shocking that there has been, once again, zero pushback from mainstream media.
This transaction should be setting off alarm bells in your head. Why is Goldman (GS), a well-respected investment bank, indirectly buying Poloniex, who only produces “profits” in cryptocurrencies? Just as how I suspect that Bitfinex was able to resell Bitcoins it purchased with Tether on fiat enabled exchanges, as long as someone is willing to put up real cash for cryptocurrencies, those 1s and 0s can indeed turn into real money.
Recall that Goldman had planned to set up an institutional cryptocurrency trading desk back in December to generate additional trading income, which has fallen off a cliff (FICC revenue was down a whopping 50% in Q4). To establish a trading marketplace, multiple parties need to have inventory available. If Goldman’s clients don’t have Bitcoin, how can it trade with them? Second, Goldman doesn’t even have any Bitcoin itself! Now how can you generate trading revenue if neither you or your client have inventory on hand?
One way to acquire inventory would be to go out there and buy it on the open market. Unfortunately, cryptocurrencies are not very liquid. While this is a hotly debated topic, I think most competent securities industry expert will concede that in today’s non-regulated market, false liquidity can be easily manufactured (fake quotes, wash trading, fake reporting, etc.). If you are not convinced, Goldman analyst sees low liquidity in Bitcoin as well. Tying this back to my earlier articles about Tether, if 1.4 billion of Tether can blow up Bitcoin from $900 to $20,000 for a $300 billion market cap gain in 2017, Goldman will never be able to acquire enough Bitcoin on the open market to build up an inventory without dramatically increasing the price of Bitcoin. Poloniex solves that problem. By generating profits in cryptocurrencies, Goldman will be able to quickly build up an inventory of cryptocurrencies, which it can then flip to its clients for a handsome profit.
Do you see where the problem is? For me, this is my worst nightmare taking shape. I previously called regulators to investigate Tether as I believe that its prevalence, and by extension the prevalence of Bitcoin, poses systematic risks to the financial system. We are now seeing the seeds of chaos being sowed right before our eyes. Note that whatever cryptocurrency the client buys from Goldman will surely show up as some form of asset, and by extension, equity. When a client buys $1 million worth of Bitcoin for Goldman, that equity doesn’t just vanish from the balance sheet; the cash is gone (to Goldman), but for reporting purposes, it has transformed into an “asset.” Just like that, something inherently worthless has become a real “asset.”
By institutionalizing Bitcoin, we will begin to see critical financial institutions carrying some of their equity in the form of cryptocurrencies. Now think back to the financial crisis, when hundreds of billions of equity capital was wiped out when toxic assets were written down to zero. When everything was on the up and up, the value of those toxic assets could be “easily” valued. But when liquidity evaporated, the true value of those assets was revealed (i.e. 0).
If we allow this to continue, we will be reliving the horrors of 2008 in the near future. I can already see salespeople feverishly pitching the next hot cryptocurrency to their clients, they may even wrap them up in an ETF, or sell them some sort of exotic structured product, and then derivatives on top of that. All of this will become reality if the current pace of institutionalization continues. For everyone who watched the Big Short, legitimizing cryptocurrencies would be this guy’s dream, but the economy will be paying for it in the end.
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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.