Cameron and Tyler Winklevoss, forever immortalized by Vanity Fair as “the Winklevii ,” are at it again. No, they are not fighting Facebook founder Mark Zuckerberg to part with even more money, a move which promoted derivatives kingpin Larry Summers to call them “as$holes,” according to Vanity Fair. Their latest battle in the spotlight centers on bitcoin, and some of what they are saying is rattling gold bugs.
Winklevii analysis on gold vs bitcoin says stability is the only area where gold wins, and that might change
There has been an uneasy correlation between the price of gold and bitcoin on several levels.
Gold has no practical value other than that assigned by human vanity. There is not a meaningful manufacturing or construction use for gold, for instance. Its primary use is as an adornment and its value is based on its perception, not its actual usefulness in society.
The same might be true of bitcoin.
But the Winklevii think the comparisons actually go deeper, and some hedge fund executives are finding value in their analysis, if with a slight smirk.
The argument in favor of the illusion surrounding bitcoin relative to the illusion surrounding gold is made on several practical levels.
The Winklevii think when comparing scarcity, durability, portability, fungibility “Bitcoin matches or beats gold across the board,” they said in a recent interview. “It’s actually not scarce, it’s fixed. You can send it around like you send an email—it’s a lot harder to do that with bars of gold.”
With the market cap of Bitcoin near $300 billion, compare this to the $6 trillion market cap of gold and you can understand why the Winklevii think “that Bitcoin disrupts gold.”
It’s all based on math you see. “We’re 300 times more correct today, and we think there’s a chance we’ll be 20 times more correct from here on out,” they said, without disclosing the algorithmic formula used to make such projections.
Even still, “the argument is not bad,” said Myrmikan Capital’s Daniel Oliver.
Gold vs bitcoin: Watch out, as the Winklevii bitcoin trade might make history if they call the top correctly
Shortly after JPMorgan stated its preference for CMEGroup’s bitcoin contract, the contract experienced light trading on the first day, but with higher volume, indicating more serious institutional support.
With such contracts representing the “mainstreaming” of the investment, short term trading volume is not where the future will be measured. Interactive Brokers Chairman Thomas Peterffy said trading bitcoin on two “reputable exchange” will make the concept “even more popular,” he told CNBC.
The question is to what extent does it challenge gold for dominance?
“Bitcoin does indeed exceed gold in every one of Carl Menger’s elements of liquidity—except one: stability,” Oliver wrote in a letter to investors. But even here, the advent of CMEGroup futures is impacting that stability.
“Remarkably low volatility, considering its bitcoin,” Trading Technologies Vice President of Crypto Trading Michael Unetich was quoted as saying of the first day of CMEGroup trading.
“A bubble needs an increasing rate of speculative inflows to avoid collapse, which is why players like the Winklevii are frantically inserting the plumbing of wholesale and retail money markets into the Bitcoin network,” Oliver said in the letter.
The Winklevii appear to be embracing this fully:
Phase 2 of that is trading a futures contract, which we’ve done with the CBOE [Chicago Board Options Exchange], that’s cash-settled, which allows institutions that are already trading up in Chicago exchanges to get exposure to Bitcoin with cash and then settle out in cash; so they don’t actually have to touch or feel Bitcoin, and they get the exposure to it. And I think the next phase to that would be something like an ETP or ETF product.
It is in the ETF the Winklevii might be able to put their hard-earned Facebook settlement to work, as Oliver pointed out:
Though institutions will be making side-bets on Bitcoin, these bets do effect the underlying market because every long futures contract requires a short. If there are no investors willing to go short, then the dealer has to create a short contract. The dealer then must balance his risk by going long the underlying commodity directly. Recall that the Bitcoin network can process only 400,000 transactions per day, which means dealers that have to make frequent Bitcoin trades would incur large expenses compared to a dealer that already has a huge amount of Bitcoin inventory on hand. This is the reason, no doubt, that the Winklevii spent $11 million of their $65 million Facebook settlement buying nearly 100,000 bitcoins at around $120 each in 2013. They can now use this inventory to backstop their dealer network.
In short what the Winklevii might be doing is establishing a method for them to exit their bitcoin trade at the top, Oliver noted:
This is extremely clever. It is not easy to sell large amounts of Bitcoin. Coinbase, the largest U.S. Bitcoin exchange, for example, allows unlimited deposits, but limits withdrawals. Right now the flows are inbound, so withdrawal limits should not matter much, yet they already have them. Imagine the scramble when everyone decides to get out. The Winklevii, by organizing a primary dealer exchange, will have no trouble liquidating their estimated $1.6 billion (and climbing) worth of bitcoin. All they have to is take the short side of the futures contracts that institutions are buying. There is a close historical parallel.
The Winklevii have been much criticized, but they could actually be the biggest winners in the bitcoin trade by not only getting in early, but potentially exiting the trade at the top, a very difficult feat for any professional trader, Oliver notes:
Calling the top of a bubble is no easy task, especially in this case. Normally a bubble pops shortly after cash flows of the speculative investments go negative. In other words, high real estate prices bring forth overcapacity, rents fall, operators cannot meet their interest payments and default, banks collapse.
Those on the inside of the market have a good view of when cash flows start going negative and can get out. In the present case, Bitcoin does not generate any cash flow, and there is no overcapacity to observe. Instead, the inflection point will come when those taking out mortgages and credit card and margin loans must sell to meet their interest payments, which will knock the price down, generate margin calls, knock the price down further, and topple the whole structure.
Banks will suffer not because they are exposed to Bitcoin directly, but because the man who loses his mortgage advance to the Winklevii will be unable to make his mortgage payment. At present, the bubble by itself is surely too small to threaten the banking system. But, like subprime housing, the Bitcoin bubble could perhaps already act to trigger the unwinding of other bubbles. This potential will grow along with the mania. Even if it not possible
Don’t cry for the Winklevii but also don’t decry them. Like it or not, if they do ride bitcoin and sell at the top, this will be regarded as one of the all-time great trades in alternative investing history.
Maybe if this happens they won’t need to use lame pick-up lines with models in the Hamptons to get attention.