“The mind shudders to contemplate the havoc of our time”

– St Jerome

What a ride. A little over a month ago, I read about a Dutch family selling their house and all of their possessions to buy bitcoin. What a mad world we live in, that this now appears to have been a good trade.

When I walked into the office yesterday morning, a bitcoin was £11,271. As I write this, it is more than a grand up, at £12,406. The market value of bitcoin increased by almost £18 billion in just a few hours.

Pure insanity.

I’ve owned bitcoin for years, so I’ve not really any right to complain about a 25% rise in my investment in less than a day, and a total return of more than 1,100% since I made my last purchase… but to be honest, I’m not sure I like the look of this week’s steroid injection to an already bull market.

Even our own Sam Volkering has been taken aback by just how fast his bullish predictions for bitcoin are coming true.

Some argue that the price of bitcoin is just a representation of public interest in blockchain technology, the system which “cuts out the middleman”, and allows for trustless transfers of assets. As there are so few publicly listed companies using this radical new system, investors just buy the asset that cannot survive without it – bitcoin. This wasn’t enough for Sam however, who’s found companies you can invest in to take advantage of the upcoming “Blockchain Collision” ­– more on that here.

Bitcoin futures contracts launch on Monday – this latest adrenaline pumping run on the bitcoin price may well be Wall Street speculators accumulating bitcoin in preparation for when this new asset is introduced to their game next week.

It’s worth noting that up until now, no has been able to short bitcoin in any meaningful way, ie those with billions of dollars at their disposal – like investment banks – have not been able to make market moving bets on the price going down.

A classic tale in the gold-bug crowd is that ever since gold futures were introduced, the gold price has been flat due to the powers that be using those futures to keep the gold price suppressed and their corrupt fiat system running.

If bitcoin truly is the fiat-money killer as crypto fanatics claim it is, will it meet a similar fate when bitcoin futures are launched? Should we expect the mother of all price collapses on Monday as Wall Street banks working for the deep state initiate a planned detonation?

Well, we’ll have to wait and see. Deep state manipulation of gold and the co-opting of bitcoin by the elites is something Tim Price and I are tackling for the December issue of London Investment Alert. In the meantime, a different bomb threat in the crypto world has caught my eye – more on that in a bit.

 

Can’t smell the cordite

From the outside looking in, the world of finance is opaque and confusing. This is partly because it is so abstract. Trying to find to find similarities between financial markets and everyday life is incredibly difficult – the rules just aren’t the same.

If you want a loan, for example, you do not write the amount you’re after and a promise to pay it back on a certificate, and let others bid for it at an auction. Yet every Friday, this is what our very own treasury department does (provided bank holidays don’t get in the way, in which case it’s the last working day of the week).

There are reasons for this difference of course – but that difference confuses and obfuscates the truth from the public who should be well informed about the state of their country’s finances.

Today, the US government will need to address its debt problem

The $20.5 trillion behemoth was originally going to be addressed in September, but Hurricane Harvey gave Congress enough room to push the problem a few months forward.

What will happen? More of the same, I expect. Who in power (or craving it) would want to stop public spending when so many voters drink on the social security trough?

It’ll be business as usual I expect… until something breaks. The feds continuing addiction to debt can only be sustained so long as other countries need dollars.

With countries in the East like China, Russia and Iran looking to lock the dollar’s influence out of their economies (just a week ago the Russian finance ministry announced it would be issuing yuan-denominated bonds), the feds complacent belief that every will always want to buy US debt may be challenged in the near future.

Explosively opaque

A culprit in Black Monday and the credit crisis, financial instruments don’t get any more abstract than derivatives. There is little in everyday life that resembles these “paper” assets, besides maybe gift vouchers, as they derive their value from something else.

They’re incredibly powerful tools, and can be used to create all manner of “synthetic” or “paper” assets. Want an inflation-proof bond that doesn’t pay interest, just gives you a fat lump sum at the end? Neither the US Treasury nor the UK Debt Management Office will issue one I’m afraid… but thanks to derivatives you can create a “synthetic” version, in the form “a zero coupon inflation-indexed swap”.

But all tools have destructive potential. And not reading the manual, or letting an idiot play with them, incurs obvious risks.

The overwhelming majority of derivatives aren’t traded on exchanges either, making their huge presence in markets incredibly hard to see.

When every, idiots included, is using them without having read the manual, and isn’t aware of how much every else is using them… things can go, well, a little awry. It is for this reason that Warren Buffett famously declared that derivatives were “weapons of mass financial destruction”.

Derivative abuse by investment firms was a key part of what caused the credit crisis of 2008. Interestingly, Blythe Masters, who created and sold many of these nukes for JP Morgan before it blew up in 2008, is now the CEO of a blockchain company called Digital Asset Holdings.

Just earlier this week, it’s been contracted to implement blockchain technology for the Australian Stock Exchange. But I don’t see any bombs here – the new system should actually drastically reduce counterparty risk.

The unregulated nature of cryptocurrencies incurs plenty of risk – those who play, must be prepared to pay dearly should things go wrong. Now, just imagine the amount of risk involved in cryptocurrency derivatives.

Double fiat money

Tether (USDT) is such a derivative. It is a cryptocurrency that derives its value from the US dollar: 1USD should always equal 1USDT. The Tether company claims to maintain this peg to the dollar by only creating 1 tether when it receives $1. However, it is not obligated to pay you a dollar if you give it its tether back, although this isn’t made all that clear by its website.

As Tether is a cryptocurrency it is not regulated by the US banking system, even though it aims to mimic the dollar as closely as it can. This means that crypto exchanges not wanting to comply with US banking regulations can just accept tethers instead of dollars and not bother with any of it.

This in itself frees Tether up for all sorts of money laundering mischief, but that’s not what I’m getting at.

Wells Fargo, who Tether used for its American banking, cut its ties and blocked Tether in April.

At the time, there were 60 million tethers (“backed” by $60 million) in existence, and it announced on its website that until its banking woes were fixed, it did not expect the supply of tethers to increase by much.

The banking situation has not changed since then

And yet as I write this there are 814 million tethers out there, supposedly backed by $814 million dollars.

It claims that institutional investors have begun dealing with it directly, and will not disclose which entities are holding this vast quantity of money.

If every believes a tether is worth a dollar and will accept it as such… the owners could just print tethers backed by nothing, buy bitcoin with it on an exchange, and then sell the bitcoin for real dollars.

Tether is linked by a major crypto exchange, Bitfinex. Some claim the bitcoin price is being artificially juiced by Bitfinex, which prints tethers to buy bitcoin whenever the bitcoin price looks set to drop, and that there aren’t nearly as many dollars backing Tether as it claims.

It’s quite the counter-narrative to bitcoin’s recent surge.

If it turns out to be true, and Tether is actually a derivative dirty bomb… the word “boom” may be attributed to cryptocurrencies for a different reason than it is now.

Have a great weekend!

Until next time,

Boaz Shoshan
Editor, Southbank Investment Research