Bitcoin, the crypto-currency that initially became infamous as the tender of choice for drug traffickers and mercenaries, may be coming to a trading desk or institutional portfolio near you – and sooner than you think.
“2014 is going to be the year Bitcoin hits Wall Street,” said Barry Silbert, founder and CEO of SecondMarket, a capital-raising platform for private companies and investment funds. Indeed, there is a growing consensus in some corners of Wall Street and the buyside community that the $7.8 billion Bitcoin industry is going to become the new, flashy darling of investors, with dedicated digital currency funds, venture capitalists and asset managers all chasing after those 12 million bitcoins currently in circulation.
“Digital currencies like Bitcoin are not going away,” Silbert explained. “And Wall Street and the regulators know this, they’ve studied how to deal with it, and now they are starting to understand its potential.” SecondMarket has gone heavy into the Bitcoin phenomenon, launching the Bitcoin Investment Trust, a $70 million open-ended trust that invests exclusively in bitcoins, as well as a dedicated desk of 10 traders who buy and sell bitcoins for the trust and other institutional clients. SecondMarket is also creating what it hopes to be the largest, best-capitalized and well-run Bitcoin exchange in the U.S., and is enlisting banks and Bitcoin-related firms to be exchange members.
Alec Petro, managing partner at Bay Hill Capital Management LLC in Duxbury, Mass., shares Silbert’s passion for Bitcoin. “We’re betting that the market is going to be there, maybe not next month, but soon,” Petro told Traders. “Institutional players are going to want to be in this space.” Petro almost single-handedly plays the role of market-maker in Bitcoin options on the Atlas ATS exchange, the only Bitcoin exchange currently offering options on the digital currency. He also runs a small fund, consisting entirely of Bay Hill Capital partners’ money, that invests in Bitcoin.
Everything Bitcoin needs to break into the mainstream of trading and investing is achievable and starting to happen, according to Petro. “More merchants are taking it and that means more liquidity, more stability in price and, ultimately, more confidence,” he said, checking off the events that will ultimately lead to the Great Bitcoin Revolution that he, Silbert and others are working toward.
The Revolution on Hold
Before the revolution can really begin, of course, Bitcoin has myriad issues to address (see sidebar).
Critics, and they are legion, point out the darker side of Bitcoin – its lack of a backing entity, like a central bank or a government; its murky mathematical origins, where bitcoins are “mined” by computers solving highly complex math equations; and, most troubling, its misspent youth as the favored currency of Silk Road, an almost comically villainous online marketplace where drug sales and illegal activities were bartered. The Federal Bureau of Investigation closed Silk Road last October, and in the process seized millions of dollars’ worth of bitcoins.
In February, the world’s largest Bitcoin exchange, Mt. Gox in Tokyo, collapsed amid a scandal of missing bitcoins and vanished accounts. Despite handling 70 percent of all Bitcoin transactions in 2013, the exchange began liquidating by April 2014. The price of a bitcoin, above $1,000 weeks before Mt. Gox’s collapse, fell as low as $420 on the exchange before it shuttered, although some panicked bitcoin holders were selling them for much less, worried that the virtual currency was virtually worthless.
“All the negatives were established early on in Bitcoin,” Petro said. “Silk Road, Mt. Gox and others – but anytime there is a new innovation, guess who uses it first? The bad guys. But I think we’re in an early stage of getting all the bad actors out.”
Once it became clear that the bottom wasn’t going to fall out on Bitcoin after the fall of Mt. Gox, the crypto-currency started to regain its lost mojo. The price of a bitcoin has climbed almost 65 percent just since mid-April to about $650 per bitcoin at press time – a development that hasn’t gone unnoticed by investors and Wall Street traders.
Still, not everyone is convinced. Fitch Ratings threw some cold water on the Bitcoin buzz in an April report, noting that although total Bitcoin consumer transactions averaged $68 million per day in February, a more than tenfold increase compared with the year before, it was still minimal compared with other payment processors and credit card companies. In trading, Bitcoin ranked better, according to Fitch, citing an average daily transaction volume in Bitcoin in February equaling approximately 1 percent of Bitcoin’s total market capitalization. Over the same period, a sample of the largest U.S. equities showed that daily trading volumes were approximately 0.6 percent of total market capitalization, according to Fitch.
Supporters of Bitcoin are unshakable in their faith, however, saying the crypto-currency will play a big part in the future of payment processing, and that future will see an increasing number of trading platforms and investment funds dedicated to Bitcoin.
The Early Adopters
Brett Stapper, co-founder of Falcon Global Capital, a Bitcoin investment fund, is one of those faithful. But he got an early lesson in how hard Bitcoin’s bad past may be to shake. Speaking at a conference in Washington, D.C., about Bitcoin, Stapper thought he’d also reach out to some legislators about issues surrounding Bitcoin. He was stunned at how negative the reaction was to it.
“They had a very bad view of Bitcoin,” Stapper said. “And that worried me because these were the people that were basically in control of the future of Bitcoin in the U.S.” Resolving to rehabilitate the image of Bitcoin in the minds of these doubters, Stapper registered himself as a lobbyist and began to educate people about Bitcoin.
Now, he said, he spends his days on the phone as a Bitcoin evangelist, talking to lawmakers and potential investors. Of course, he’s got skin in the game – Falcon Global Capital runs a $7 million SEC Regulation D Private Investment Fund and is launching a second fund, for offshore investors, later this summer. The funds operate similarly to a gold-holding hedge fund, offering investors exposure by purchasing bitcoins on their behalf, with investments ranging from $25,000 to $10 million, according to the firm’s Website. The bitcoins are then stored in Falcon Global Capital’s digital vault, providing investors easy access and protection from theft.
Fund firms like Falcon Global, SecondMarket and Bay Hill aren’t the only ones to have fallen under Bitcoin’s spell. The Winklevoss brothers, best known for their legal face-off with Mark Zuckerberg, the founder of Facebook, are awaiting final approval from the SEC for the first-ever ETF that tracks the price of bitcoins. Hedge funds and trading firms such as Fortress Investment Group, Sun Trading, Tradebot Systems, Coin Capital, Pantera Capital Management, Cedar Hill Capital and Havelock Investments have launched Bitcoin funds, or have gotten involved in trading or acquiring bitcoins. Venture capital firms such as Liberty City Ventures and Core Innovation Capital are investing heavily in Bitcoin start-up support companies, like wallet companies (which allow users to hold and store bitcoins) and Bitcoin-focused tech companies that are helping set up exchanges. Tech exec heavyweight Marc Andreessen also is a Bitcoin fan, supporters like to point out.
Still, the number of Bitcoin fan club members who are actually willing to put up their dollars in terms of investment or trading infrastructure development is small, albeit growing. “We are on the front lines of Bitcoin, paving the way for others to get involved,” Stapper said, adding that Falcon Global Capital is anticipating its funds will grow to a combined $100 million in assets by the end of the year.
SecondMarket’s Silbert is also expecting to have a very busy summer. SecondMarket is planning to launch its large U.S. Bitcoin exchange in a few months, and is spinning all of its Bitcoin operations – including the exchange and the Bitcoin Investment Trust – into a yet unnamed separate company.
Right now, Silbert spends his time talking to potential exchange members, including Bitcoin start-ups and Bitcoin pay-processing companies as well as some Wall Street banks. The exchange will be based on the New York Stock Exchange’s “hub-and-spoke” model in which the exchange only interacts with its members, Silbert said. The exchange will also include its own clearing operation and a self-regulatory unit. “The Bitcoin industry is highly fragmented,” he said, explaining the need for the new exchange. “That’s why so much of the larger trading takes place off-market – a $5 million purchase of bitcoins would rock the price.”
Shawn Sloves, co-founder and CEO of Atlas ATS, also spends a lot of time talking to potential investors, mostly institutional players and hedge funds, trying to nudge Bitcoin onto the main stage. “The firms that we have been meeting with are private investment firms, and the funds either being raised or invested are partners’ money or funds from the investment company,” Sloves said. “What we see in the space, rather than a large well-known public or private fund creating an investment vehicle within their existing organization or fund, is that they create new legal entities to manage the Bitcoin investment.” Despite investment funds’ arms-length participation, Sloves estimated that there are more than 50 asset management firms with up to $100 million in newly created dedicated funds to invest in digital currency – with more firms expressing their interest to Atlas ATS with every passing week.
The Atlas ATS exchange platform is where institutional players can trade digital currencies among themselves in a sort of Bitcoin dark pool. “We’re leading the charge on this from a technology point of view,” said Sloves, who previously developed trading products and networks at Mantara and SunGard. He is also co-founder and CEO of Fundamental Interactions, a tech company that develops virtual trading platforms and related appliances.
Sloves said he knew that if Wall Street, merchants, the big banks and, most importantly, buyside traders were ever going take to Bitcoin, they needed a platform that made sense to them. “Wall Street and buyside traders hate Web-based trading systems, and we knew we had to create something like they were used to working with or Wall Street would not use it,” he explained, adding that Atlas ATS used Fundamental Interactions’ virtual trading platform – one that Wall Street traders were already familiar with – and adapted it to trade in Bitcoin. “The infrastructure has to look like what they are used to.”
Sloves said that Atlas ATS currently trades about 60,000 bitcoins a month, fewer than 1 percent of total global trading volume; however, he expects the exchange to reach 5 percent of total trading volume by the end of the year. Sloves predicted that when more merchants and participants coming on board with Bitcoin, they will need to manage their exposure through trading. “They need this platform to support the ecosystem – within the next two years, we want to build this infrastructure around the world.”
Flipping the Bitcoin
Bay Hill’s Petro, who acts as market-maker for Bitcoin options trading on the Atlas ATS exchange, said he now sees more players, including smaller institutional investors and merchants, coming to trade Bitcoin options. “We envision that some of the biggest institutional players are going to have to maintain a presence in Bitcoin and have that presence managed in the same way that the institution manages its exposure to yen or dollars,” Petro said.
Right now, trading in Bitcoin is decidedly one direction – up, Petro noted: “Most trading strategies in bitcoins are long strategies, since everyone wants to buy.” Therefore, much of his options trading activity is done just like a forex spot option. “You exchange your currency to go long or short in bitcoins; then when the option expires, it settles into your physical currency, dollars or yen or whatever,” he said.
As for the level of trading activity in Bitcoin options, he is pleasantly surprised and hopeful going forward. “We have gone from making one or two option trades per day to 10 to 15 option trades per day over the past five weeks,” Petro said. “It’s hard to give a percentage but I like the trajectory, especially given that there has basically been no marketing dollars spent yet.”
He’s mainly seen option players engaging in speculation for further appreciation in the price of bitcoins by buying calls, and sometimes selling puts to finance the purchase, he said. “This has been especially popular in the last month as we’ve seen the price of bitcoins in dollars appreciate almost 80%.” With the current price of a bitcoin at about $650, Petro said he is seeing long-holders hedge their investment by buying puts in the $550 to $650 range or selling out-of-the-money calls as far out as December, striking at $1,200 to $1,500.
“There are different users entering the trading ring – speculators who want a safe, leveraged way to bet on the upward movement of the price, as well as some merchants and Bitcoin miners who are sitting on bitcoins and need to hedge their long positions,” he explained.
In addition to managing the options business, Petro also oversees Bay Hill’s Bitcoin investment fund in which thus far, Bay Hill’s partners are the only ones participating. “Our fund investors don’t want to talk about Bitcoin; I don’t even bring it up with them,” laughed Petro, predicting that eventually the mainstream investing public, asset management teams and Wall Street’s fleet of trading desks will all be involved with Bitcoin.
For now, though, Petro is content with the part he’s playing in fomenting that change: “We’re making liquidity, we’re making options, and we’re playing a part in this evolution.”
