Matt Levine’s Money Stuff: Bitcoin Traders and Index Funds

LAGOS (Capital Markets in Africa) – Goldman Sachs Group Inc. is weighing a new trading operation dedicated to bitcoin and other digital currencies, the first blue-chip Wall Street firm preparing to deal directly in this burgeoning yet controversial market, according to people familiar with the matter.

Literally, why not? Banks — Goldman especially — trade things. If there is a thing that trades — and, particularly, if it is a purely financial asset that trades electronically and is popular among hedge funds and high-net-worth individuals — then there is almost a default presumption that a bank will trade it; you need a reason not to trade it. If a hedge fund calls up Goldman and asks “hey I would like to buy bitcoin, could you custody and margin it for me and also explain how it works,” why would Goldman say no? (“‘In response to client interest in digital currencies, we are exploring how best to serve them in this space,’ a Goldman spokeswoman said.”) The purpose of an investment bank is to surprise and delight hedge funds, or at least to accommodate their reasonable requests, and if they want to buy, then Goldman had better be selling.

Particularly if the market is sort of dumb and messy and volatile and inefficient and no other sophisticated banks are trading it. That is how you make lots of money. The world needs exotic bitcoin derivatives, and who better to build them than Goldman Sachs? (Disclosure: I used to build derivatives at Goldman.)

Obviously, though, there are reasons not to trade bitcoin! There are regulatory reasons, for instance. Bitcoin itself, for all that you can’t read a bitcoin article without references to “anarchists and drug dealers,” seems to be on relatively firm regulatory ground these days; no one is going to get arrested for trading bitcoin. (People might get arrested for failing to do anti-money-laundering checks on their bitcoin counterparties, but that does not strike me as a huge worry for Goldman.) But “other digital currencies” present thornier issues: If everyone wants to exchange their bitcoins for the latest hot new initial coin offering, and if the sellers of that ICO are not too concerned about whether it complies with U.S. securities laws, then Goldman may have to go out on a bit of a limb in figuring out what’s legal and what isn’t. I would expect Goldman’s lawyers to be more conservative about securities-law compliance than many ICO founders — and cryptocurrency exchanges — seem to be.

The other reason not to trade bitcoin is that, as far as I can tell, the fate of any bitcoin exchange/wallet/bank/custodian is to be hacked. That is just how bitcoin works: You buy bitcoins on an exchange, and you store them at the exchange because it’s a pain to keep your private key yourself, and then the exchange gets hacked and your bitcoins get stolen. (“There have been at least three dozen heists of cryptocurrency exchanges since 2011,” Reuters noted last week.) If Goldman gets into that business — custodian and margining and prime brokering bitcoins for clients — then it will be a target for hackers. And perhaps it will be hacked, and its bitcoins will be stolen, and Jamie Dimon will gloat a little.

Or perhaps Goldman will improve on the exchanges’ track record of losing their customers’ bitcoins. Perhaps Goldman will end up with a cryptocurrency trading platform that is robustly compliant with securities laws, and robustly secure from the hackers that plague other cryptocurrency trading venues, and robustly capitalized so that it can compensate customers if it is hacked. And other banks will follow, and will develop shared best practices for security and compliance. And if you want to buy cryptocurrency, and you want to make sure that your trading is legal and your assets are safe, then you will naturally gravitate toward the big banks. And bitcoin, the anarchic trustless currency intended to displace the big banks that nobody trusted anyway, might become just another profit center for those banks, if they turn out to be more trustworthy than the alternative.

Cryptocurrency index fund.
Well, when I think about what I want from cryptocurrencies, the number one thing that comes to mind is sensible low-cost diversification:

Enter Bitwise Asset Management, which is launching the HOLD 10, a new passively managed index fund of the top 10 cryptocurrencies by inflation-adjusted market capitalization.

“It’s too hard to conveniently and securely own a portfolio of cryptocurrency,” says cofounder Hunter Horsley. “We felt [what] needed to exist was a robust index that tracks the large cap cryptocurrencies and the market as a whole.”

The HOLD 10, named for a common saying in crypto (and Bitcoin in particular) to hold one’s coins rather than sell, will be sold as a traditional security to accredited investors who must meet income or net worth minimums ($200,000 a year in income or $1 million net worth).

Okay I am going to stop you there and say: “a common saying in crypto (and Bitcoin in particular) to hold one’s coins rather than sell”? That’s a … saying? Like one of those old-timey stock market aphorisms — “sell in May and go away,” “buy the rumour, sell the news” — except that it’s “buy bitcoins and never sell them”? “I remember when I was a young whippersnapper like you,” the grizzled bitcoin vet tells the novice trader, “I would sometimes sell bitcoins. But then I learned the secret of the market, which is: hold.” If that’s really a thing, it’s a bad sign for Goldman’s trading business.

One basic principle of contemporary finance is that logical consistency imposes no constraint on the combination of buzzwords. You might think that a belief that bitcoin will be the dominant transactional currency of the future would fit uncomfortably with an index fund that bets on 10 different cryptocurrencies, but whatever. You might think that a belief that bitcoin will disintermediate the banks and return financial power to the people would fit uncomfortably with buying it through an index fund, or Goldman Sachs, but whatever. You might think that the decentralized nature of the blockchain would fit uncomfortably with central banking, but central banks just love blockchain projects. This is is not just about bitcoin and blockchain, either: You might think that the rise of passive investing would fit uncomfortably with concentrated long-shot bets on tiny industries, but there are exchange-traded funds for drones and whiskey and millennials and whatever other niche interest you can think of. Buzzy modern financial concepts are infinitely combinable, and if they contradict each other, that just makes the combination more interesting.

Still elsewhere in cryptocurrency, here’s a story about Monaco, a digital currency that “gained as much as 695 percent in value since May 17, when its issuing company tweeted that it would offer a Visa Inc.-branded payment card,” without actually having a deal with Visa. (“In retrospect, we probably wouldn’t put the Visa name on there yet,” says its chief executive officer.) And here’s a story about how hedge funds get preferential discounts on initial coin offerings and then quickly flip their tokens at full price.

Ticket bots.
A common story of technology is (1) there is some simple repetitive task that people do, (2) someone figures out a way to do that task more quickly and efficiently using technology, (3) that person gains a competitive advantage, and (4) everyone gets mad at her. Here’s one:

Ticketmaster says its customers are being ripped off by companies that use illegal “bots” to scoop up large quantities of highly sought tickets and it’s fighting back.

The Beverly Hills, California-based company sued Prestige Entertainment, claiming it used computer programs to illegally buy as many as 40 percent of the available seats for performances of “Hamilton” in New York and the majority of the tickets Ticketmaster had available for the Mayweather v. Pacquiao fight in Las Vegas two years ago.

One way to read this is that Prestige is a much more efficient pricer of “Hamilton” and Mayweather tickets than Ticketmaster is, and so used its fast reaction time and smart pricing algorithms to buy underpriced tickets and resell them at fair value. (Speed, after all, would be no advantage to Prestige if it then sold the tickets at a loss.) In financial markets, that would earn it a high-five and a lot of money, but I guess in the “Hamilton” market no one thinks about things that way.

SEC hack.
The more I learn about the hack of the Securities and Exchange Commission, the less I understand:

Hackers who broke into a U.S. regulatory database that stores market-moving corporate information also accessed personal details about two people, including their names, dates of birth and Social Security numbers.

Remember, the hackers got access to test filings in Edgar, the SEC’s system for disclosing corporate information. Edgar filings pretty regularly contain the names and phone numbers of people involved in the filing — typically, the lawyers who wrote it — but they don’t normally contain their Social Security numbers. These test filings … did? (Or, one did: “An EDGAR test filing accessed by third parties as a result of that intrusion contained the names, dates of birth and social security numbers of two individuals,” says the SEC.) Why? The point of doing a test filing is to make sure that your Edgar connection works and that you have the formatting right. I suppose if you test-filed your earnings release and discovered that, instead of your quarterly Adjusted Ebitda, you had accidentally included your chief executive officer’s name, date of birth, Social Security number, home address and credit-card numbers, you would want to revise that filing, but how would that happen in the first place?

Meanwhile, here is a guy who thinks that the SEC was hacked because it’s a more vulnerable target than the banks:

“Sun Tzu wrote in The Art of War that attackers avoid surfaces and flow to gaps like water flowing down hill,” said Nate Fick, chief executive of cyber security company Endgame. “The banks are the surfaces and the SEC was a gap.”

Well, sure, yes, but remember that at its core the system that was hacked was a system for the immediate public disclosure of information. You shouldn’t expect to get that much secret stuff from Edgar. If you really want a security gap, you could probably hack my old Friendster page, but that’s not quite as good as hacking a bank, is it?

Elsewhere in hacks: “Equifax Made Major Errors That Led to Hack, Ex-CEO Concedes.”

Wells Fargo.
The Wells Fargo & Co. fake accounts scandal was at its heart about a problem of incentives. Wells Fargo pestered its branch bankers to open lots of accounts. The bankers responded to this pressure by opening millions of fake accounts. Wells Fargo did some amount of quality control by firing people — 5,300 of them — for opening fake accounts. You’d think that 5,300 firings might discourage other employees from opening fake accounts. But you can’t really evaluate the incentives based on that number alone; you’d also  need to know how many people Wells Fargo fired for not opening fake accounts, and thus not meeting their sales quotas. If Wells Fargo fired 5,300 people for opening fake accounts, and 20,000 people for not opening fake accounts, then the rational move might have been to open fake accounts.

When the scandal first came out, Wells Fargo didn’t know that latter number, how many people were fired for not meeting the quotas. But here is a story about how “Wells Fargo & Co. Chief Executive Officer Tim Sloan apologized for a phony accounts scandal and said the U.S. bank had hired back nearly 2,000 workers who had quit or were fired.” It actually seems to be 1,780 re-hired workers, a somewhat disappointing number. At least 1,780 people were fired (or quit) for the wrong reasons, but that’s significantly less than the 5,300 who were fired for the right reasons. But of course the 1,780 people who were re-hired may just be the tip of the iceberg; if you were pushed out of Wells Fargo years ago for not opening fake accounts fast enough, I can see why you might not want to come back. “About 5,300 employees were fired for taking part in the misconduct, the bank has said, but many more employees left or were pushed aside because they could not abide the culture.” But the actual numbers remain mysterious.

Source: Bloomberg Business News