money

Hedge Funds push the price of bitcoin to new highs

Analysts say a significant amount of the new money is coming from large institutional investors

New York Times News Service
13:42 November 11, 2017

San Francisco: The chief executive of JPMorgan Chase, Jamie Dimon, has called bitcoin a fraud and made it clear that he will not allow his bank to begin trading the virtual currency any time soon.

But that has not stopped a growing wave of big Wall Street investors — many of them hedge funds — from pouring their money into bitcoin, helping extend an eight-month spike in its price.

The price of a single bitcoin climbed from below $6,000 (Dh22,020) two weeks ago to above $7,400 on Monday, more than it moved in the virtual currency’s first seven years in existence.

Since the beginning of the year, the value of bitcoin has jumped over 600 per cent, putting the combined value of all bitcoins at about $120 billion, or more than many of the largest banks in the world.

The rise has been fuelled by several factors, including the sudden interest in virtual currencies from small investors in Japan and South Korea.

Now market watchers say a significant amount of the new money is coming from large institutional investors, many of them hedge funds looking to capitalise on the skyrocketing price.

Many of the hedge funds were set up over the last year to invest exclusively in virtual currencies. The research firm Autonomous Next has said the number of such hedge funds has risen from around 30 to nearly 130 this year alone.

More general-purpose hedge funds have also been buying up bitcoins, like one run by Bill Miller, a well-known mutual fund manager who spent most of his career with Legg Mason.

Even more big investors are looking at the space after the Chicago Mercantile Exchange announced last week that it would launch a bitcoin futures contract in the next few months. The contract will make it easier for financial institutions plugged into the exchange to get involved with the bitcoin market without having to worry about holding bitcoins themselves.

Bobby Cho, head trader at one of the largest bitcoin trading businesses, Cumberland, said that after years of hesitancy, institutional investors now accounted for most of his business.

“The vast majority of the trading we do is with institutions,” Cho said. “The education and research have turned into real-life activity.”

The entrance of these big investors creates new risks for the bitcoin.

Cascade of withdrawals

Kevin Zhou, a longtime trader in the space, said that hedge funds were more likely than small investors to pull out a lot of money at once, and that the bitcoin was still small enough that a single fund’s cashing out could cause the price to drop sharply.

“You could get a possible run on the bank if one large investor withdraws and that causes the price to tank,” said Zhou, a co-founder of the trading firm Galois Capital. “That could cause a cascade of withdrawals.”

The rising importance of Wall Street is an unexpected turn for a virtual currency that was invented in 2008 by an anonymous creator known as Satoshi Nakamoto and designed to operate outside the traditional financial system.

Bitcoins, even those held by hedge funds, are recorded and stored on a decentralised database known as the blockchain, kept on a network of computers around the world. The whole system is governed by open source software that is maintained by a community of volunteer programmers.

The lack of backing from any government or established institution has concerned many large banks. The chief executive of Credit Suisse, Tidjane Thiam, said last week that he saw no inherent value in bitcoin, joining the list of bankers who have called the market a bubble.

But some financial leaders, including Goldman Sachs’ chief executive, Lloyd Blankfein, and Christine Lagarde, head of the International Monetary Fund, have defended the idea that virtual currencies could one day play a role in the global financial system because they can be obtained by anyone with internet access.

The debate about bitcoin has been part of a broader explosion of interest this year in the various technological concepts introduced by the virtual currency. Many banks, including JPMorgan, have been trying to find ways to create their own decentralised databases, like the bitcoin blockchain, that could provide a more reliable and secure way to track information.

In the technology industry, there has been a rush this year of initial coin offerings, a way for entrepreneurs to raise money by creating and selling their own custom virtual currencies. Initial coin offerings have taken over $3 billion from investors this year after attracting almost no interest before.

These coin offerings have created their own demand for bitcoins because the new coins generally have to be bought with an existing virtual currency like bitcoin.

Software

The interest in bitcoin could be dampened in the coming weeks, however, by a debate among bitcoin followers.

Bitcoin start-ups and programmers have been fighting for nearly three years about the best way to update the software that governs the currency and the network on which it lives.

The battle is expected to come to a head this month when new bitcoin software, backed by many of the biggest virtual currency start-ups, is released. The new software aims to double the number of transactions flowing through the network. Currently, the computers processing bitcoin transactions are limited to about five transactions per second.

Most of the programmers who maintain the bitcoin software have opposed the changes because they say it would make it harder for individuals to track their own bitcoins.

Some of the computers on the network are likely to update to the new software while others stay with the existing rules, creating a split, or fork, in the network that would result in two separate bitcoins.

A bitcoin fork could prove disruptive and drive away investors. But several signals suggest that the proposed rule changes are not likely to win enough support to survive for long, which would leave the status quo in place.

Bitcoin has already survived past attempts to fork the software and create imitators. In August, a group of former bitcoin supporters created Bitcoin Cash, a totally separate virtual currency that makes it easier to do small transactions, like paying for a cup of coffee.

The price of bitcoin temporarily wavered before Bitcoin Cash was introduced. All previous holders of bitcoins were automatically granted the same number of Bitcoin Cash, and the value of those has also been rising, essentially doubling in the last month.

Chris Burniske, a co-author of a book on virtual currency investing, “Cryptoassets,” said most of the new investors were not too concerned about the exact design of a bitcoin or the current debates.

“I don’t think a lot of the new buyers are overly concerned about the long-term technical aspects of bitcoin,” he said. They are “simply approaching it as a financial instrument.”