Fortune‘s recent piece on betting against the Bitcoin “megabubble” reflected poorly both on the Bitcoin financial markets and on the mainstream financial press. Here’s how to short Bitcoin the right way.
Getting the Background Right
Maybe Stephen Gandel was having a bad day or working to an impossibly tight deadline with How to bet against the bitcoin megabubble. In attempting to answer the question “Can you bet on the likely eventual bitcoin crash?” it seems to me that the Fortune article progresses from just plain wrong to outright zany.
Fortune says “it’s an expensive trade” and warns that “even if you’re right, you won’t walk away with much” before suggesting that traditional shorting is difficult since “borrowing bitcoins is nearly impossible”. Although he nods in the direction of “a company based in Hong Kong…that seems to offer bitcoin shorting”, Gandel tells us he “couldn’t find out much about it”.
That would be Bitfinex, one of the currency’s leading trading platforms, handling exchange both in house and routed via Bitstamp. (Its total volume during the last 24 hours was around 14,000 BTC.) More to the point, users can currently borrow bitcoins at around 2% per annum; as of this writing, the site shows just under 1000 BTC in outstanding loans at an average interest rate of just under 4%. Nor is it in any way difficult to find out more about the site, and in my experience, the primary operator Raphael Nicolle is both very helpful and very quick to respond to email enquiries. The site’s underlying software even has some interesting lineage, being based on a greatly revised and cleaned-up version of the now-defunct Bitcoinica platform; that earlier version was famously written by a Chinese high school student and was riddled with security problems.
Having passed over the obvious platform for simply shorting the currency, Fortune moved on to “ICBIT, a bitcoin exchange…run by a guy in Moscow”. ICBIT is a futures platform, and it’s a little more involved than “a guy in Moscow”; here again, in my experience, the folks behind this leading platform are friendly and helpful and more than willing to discuss the operation in some detail. The article complains that “to see the prices of the contracts, you had to get your account up and running and deposit a minimum of 0.1 bitcoins”. It’s hard to tell when Gandel actually visited the ICBIT site, but it must have been a good while ago, since for a long time now the site has been showing available contracts, total volume, open interest, and current bids and asks right on the front page. These details are impossible to miss.
With straightforward shorting dismissed out of hand, and with the leading Bitcoin futures platform meriting just a passing mention, Gandel moves on to MPEx. He doesn’t mention the Romanian operator’s reported associations with spamming or the pornography industry, and he doesn’t mention the claim in the site’s FAQ that it never hedges the options it trades in. Nor does he mention the usurious pricing of the currency options, with implied volatility frequently far above historical volatility. (Deafeningly loud alarm bells like these might explain why the site’s volume is so low and why it is largely ignored by those who have acquired financial experience elsewhere than in Bitcoin’s brief childhood. It’s notable that as of this writing, the most profitable single trader on ICBIT over the last 30 days has generated nearly as much profit as MPEx has generated in options revenues for the entire trailing three-month period.)
Gandel does go on, at least, to explain what a terrible deal the options represent for those wishing to use them to “bet against” the cryptocurrency.
Getting Bitcoin Shorting Right
For straightforward shorting, it’s hard to beat a margin interest rate that is almost always under 5% per annum at Bitfinex. Figure in transaction costs of up to 0.35% and a bid/ask spread of a fraction of a percent, and all those headwinds Gandel imagines pretty much disappear: borrow some bitcoins, sell them for dollars, and buy them back later to close the position, pocketing the difference. Using Gandel’s example of a 55% fall in the value of the currency over the course of a month, it would be challenging to profit by much less than 50% of the borrowed amount (or far more, relative to the collateral requirement). For the sake of the example, borrow 1 BTC and sell it for $1000; buy it back at $450, and if you haven’t made at least $500 in profit, you’re doing something wrong.
For potentially more leveraged shorting via futures, ICBIT wins the day. With Mt. Gox spot currently around $1050, March 2014 futures on ICBIT are bid at around $1409. Sell 140 contracts — enough for roughly 1 BTC at $10 per contract — and if BTC vs. USD falls to $450 by mid-March, you gain approximately 2.12 BTC, which at $450 a pop is around $954. This transaction currently requires around 0.18 BTC in collateral, incidentally, plus 0.0001 BTC per contract per trade. Even if BTC vs. USD stays the same as it is now, the premium for the March futures means that shorting them will still net you around .34 BTC when the futures price converges with spot at settlement, which at $1050 each is $357. Because these are futures, the current futures price may be significantly above or below current spot. (In Bitcoin circles, this is commonly referred to as contango or backwardation, respectively, although this is technically incorrect, since those terms refer not to the difference between the futures price and spot, but to the difference relative to the expected price at settlement.)
In practice, experienced traders rarely make either of these types of moves — direct shorting or selling futures — in isolation. More commonly, an overall position is hedged, via one position in the spot market and another in the futures market, or via opposite trades in futures with different settlement dates. After all, in reality, nobody knows whether they’re entering a short position right before a 55% fall, or whether they’re about to get trounced by a strong surge upward.
Last but not least, as I discussed in an article on Bitcoin derivatives back in May (see “Bitcoin Derivatives, Liquidity and Counterparty Risk”), BTC.sx also offers leveraged exposure to BTC vs. USD — either long or short — that bears some similarity to CFDs. (Under the hood, it’s actually margin trading coupled with a guaranteed stop loss order, but this complexity is hidden from the end user.)
My Personal Take on Shorting Bitcoin
For a short time, I managed a very modest (2000 BTC) Bitcoin-denominated hedge fund, which at various times used all three of the platforms I mentioned above — Bitfinex, ICBIT, and BTC.sx — for both net long and net short positions. As of this writing, we’re just getting set up a second, smaller fund, focusing specifically on volatility in the value of Bitcoin versus other currencies, and I have no doubt we’ll be making use of all three again.
The important point is that for those expecting the kinds of tools investors are accustomed to in the fiat world, and in particular for those with an interest in shorting the cryptocurrency, Bitcoin finance is not quite the train wreck that the Fortune article’s single experience with one service might have you believe. It’s entirely possible to get serious work done using the tools available right now. Yes, there are problems and limitations — very big ones, which I’ve discussed elsewhere — but the Fortune article’s outlook on the field seems to me to range from just plain wrong to outright zany.
If you are an investor who wants to “bet against the bitcoin megabubble”, as Fortune put it, you have no fewer than three decent DIY methods available to you — or even four, if you count the approach which Gandel rightly found so lacking in merit.
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