Bitcoin Has A “Whale” Problem: 1,000 Investors Control Nearly Half The Market
If Jay Gould were alive today, he would’ve traded bitcoin.
Perhaps the most blatant hypocrisy perpetrated by bitcoin evangelists is their insistence that bitcoin and other digital currencies represent a return to a truly democratic financial system beyond the control of banks and other special interests, where players small and large can earn enormous profits simply by HODLing.
Of course, this idealistic take couldn’t be further from the truth. As Bloomberg points out, the markets for bitcoin and most of its cryptocurrency clones more closely resemble the US equity market of the Gilded Age, where a handful of powerful traders and brokers colluded to move prices in their favor. And because securities laws at the time were virtually nonexistent, the big players minted suckers with impunity.
According to Bloomberg, about 1,000 so-called “whales” control 40% of the bitcoin in circulation, giving them unrivaled leverage over the broader market. And because there are no laws explicitly banning collusion in digital currency markets, only the most blatant pump-and-dump operations risk being prosecuted as fraud.
And with the price skyrocketing like it has in recent days, the incentive for these traders to begin taking profits has never been more pressing.
About 40 percent of bitcoin is held by perhaps 1,000 users; at current prices, each may want to sell about half of his or her holdings, says Aaron Brown, former managing director and head of financial markets research at AQR Capital Management. (Brown is a contributor to the Bloomberg Prophets online column.) What’s more, the whales can coordinate their moves or preview them to a select few. Many of the large owners have known one another for years and stuck by bitcoin through the early days when it was derided, and they can potentially band together to tank or prop up the market.
“I think there are a few hundred guys,” says Kyle Samani, managing partner at Multicoin Capital. “They all probably can call each other, and they probably have.” One reason to think so: At least some kinds of information sharing are legal, says Gary Ross, a securities lawyer at Ross & Shulga. Because bitcoin is a digital currency and not a security, he says, there’s no prohibition against a trade in which a group agrees to buy enough to push the price up and then cashes out in minutes.
As Bloomberg explained, the manipulation in bitcoin is extreme because many of the big players know each other from having been involved in the digital currency space since its infancy. Add to this the fact that the risks are incredibly asymmetrical – there’s tremendous upside in terms of profits if they can successfully pull it off. And the chances of them drawing the scrutiny of law enforcement are relatively low.
“As in any asset class, large individual holders and large institutional holders can and do collude to manipulate price,” Ari Paul, co-founder of BlockTower Capital and a former portfolio manager of the University of Chicago endowment, wrote in an electronic message. “In cryptocurrency, such manipulation is extreme because of the youth of these markets and the speculative nature of the assets.”
The recent rise in its price is difficult to explain because bitcoin has no intrinsic value. Launched in 2009 with a white paper written under a pseudonym, it’s a form of digital payment maintained by an independent network of computers on the internet‚ using cryptography to verify transactions. Its most fervent believers say it could displace banks and even traditional money, but it’s only worth what someone will trade for it, making it prey to big shifts in sentiment.
Case in point: Some of these so-called whales admitted in an interview with Bloomberg that they regularly incorporate what would in the equity market be considered material nonpublic information into their trading strategies.
Like most hedge fund managers specializing in cryptocurrencies, Samani constantly tracks trading activity of addresses known to belong to the biggest investors in the coins he holds. (Although bitcoin transactions are designed to be anonymous, each one is associated with a coded address that can be seen by anyone.) When he sees activity, Samani immediately calls the likely sellers and can often get information on motivations behind their sales and their trading plans, he says. Some funds end up buying one another’s holdings directly, without going into the open market, to avoid affecting the currency’s price. “Investors are generally more forthcoming with other investors,” Samani says. “We all kind of know who one another are, and we all help each other out and share notes. We all just want to make money.” Ross says gathering intelligence is legal.
And investors who buy into smaller tokens are at an even greater disadvantage.
Ordinary investors are at an even greater disadvantage in smaller digital currencies and tokens. Among the coins people invest in, bitcoin has the least concentrated ownership, says Spencer Bogart, managing director and head of research at Blockchain Capital. The top 100 bitcoin addresses control 17.3 percent of all the issued currency, according to Alex Sunnarborg, co-founder of crypto hedge fund Tetras Capital. With ether, a rival to bitcoin, the top 100 addresses control 40 percent of the supply, and with coins such as Gnosis, Qtum, and Storj, top holders control more than 90 percent. Many large owners are part of the teams running these projects.
Unsurprisingly, Bloomberg managed to find someone to defend the status quo: Whales won’t dump their holdings, this person argued, because they “have faith in the long-term potential of the coins.” This strikes us as a naïve assumption.
Some argue this is no different than what happens in more established markets. “A good comparison is to early stage equity,” BlockTower’s Paul wrote. “Similar to those equity deals, often the founders and a handful of investors will own the majority of the asset.” Other investors say the whales won’t dump their holdings, because they have faith in the long-term potential of the coins. “I believe that it’s common sense that these whales that own so much bitcoin and bitcoin cash, they don’t want to destroy either one,” says Sebastian Kinsman, who lives in Prague and trades coins. But as prices go through the roof, that calculation might change.
While the concentrated holdings of the modern bitcoin market should give potential investors pause, in some ways, it’s not all that different from the modern equity market. As we pointed out back in September, the Bank of Japan owns a staggering 75% of the domestic ETF market. Increasingly, equity ownership in the US and around the world is becoming increasingly concentrated in the hands of central banks, sovereign wealth funds and the largest asset managers like BlackRock, Fidelity and Vanguard.
While the whales can exercise unrivaled influence over the price of bitcoin, they aren’t the only players in the bitcoin market with a natural inclination toward self-dealing. As Bill Blaine pointed out, nearly every bank knows bitcoin’s extraordinary gains are a crowd delusion fuelled by the extraordinary promise of free wealth.
Yet, many will be willing to trade and settle them for their clients – largely retail. So, while the bitcoin bubble has (for now) blessed hundreds of thousands of mom and pop investors with spectacular returns, these gains will only continue as long as the cartel allows them too.