Risk management

Our two cents on bitcoin

Simply not trading bitcoins does not necessarily protect an investor from damage caused by a bursting bubble.
(December 2017)


Joost Dijkers

Risk Management

  • chevron-right The price explosion of bitcoin is a bubble.
  • chevron-right Simply not trading bitcoins does not necessarily protect an investor from damage caused by a bursting bubble.

What we are witnessing in bitcoin right now – not just its price explosion but especially the hype fueling that explosion – is a bubble. And bubbles will burst. It may happen next week. Or bitcoin may continue to rise for another year before bursting. But burst it will, as all bubbles eventually do.

Our two cents on bitcoin (2017)

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The fact that it is a bubble right now doesn’t mean that bitcoin and/or other crypto-currencies cannot ultimately succeed. Here in the Netherlands, 380 years after the bursting of the original Tulip bubble, many Dutch enterprises continue to flourish in the tulip business. In Britain, 180 years after Railway mania came to an end, there still is a functioning railway system. And in our modern world, 15 years after the Dot-com bubble burst, internet is more popular than it has ever been. As a matter of fact, one of the dominant stock market trends in 2017 is driven by more and more people buying things online instead of in a brick-and-mortar shop.

The fact that it is a bubble also doesn’t mean that investors cannot make money by trading it. Over at Transtrend we are just a little bit too young, so we missed the Tulip bubble and Railway mania. But we did participate in the Dot-com bubble. As did most investors of our age, because while the bubble inflated these ‘internet stocks’ formed a growing share of the major stock indices, such as the Nasdaq. With our Diversified Trend Program we may have made some money in the bubble’s inflation. And we most certainly did profit from it when it burst around the second half of 2000. The same holds for the housing bubble of the following years, which developed into the credit crisis when it burst in 2007. Needless to say, this is not indicative of any future results.

Bubbles are of all times. They seem to be an ineradicable integral part of the way financial markets function.

More than 25 years of trend following

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Bubbles are of all times. They seem to be an ineradicable integral part of the way financial markets function. They are a phenomenon that we as investors have to deal with. At the moment we are witnessing the hallmarks of bubbles, also in some markets that are not at all related to bitcoin. Unfortunately the financial markets cannot be divided into one area displaying bubbles, and another area that is insensitive to them. The consequence is that simply not trading the markets that express them will offer no protection from the damage that bursting bubbles cause.

This is also the case for bitcoin. Now futures on bitcoins have started to be traded on the CBOE and the CME, the chance that an eventual burst of the bitcoin bubble will affect other investments has increased significantly. The problem with bubbles bursting is that they always go hand in hand with overly speculative investors losing more than they possess. That poses a risk to clearing brokers and clearing houses. And therefore also to other investors who deposited part of their funds at these places. In this respect, we fully understand and welcome the decision of the clearing brokers that Transtrend works with not to clear bitcoin futures for now.

Tulips

But this mitigates the risk only partially. All of the margins deposited at the clearing houses of CBOE and CME are fundamentally at risk. When we trade VIX futures on the CBOE for our clients, or the Canadian dollar, Treasury bonds, or wheat futures on the CME, we deposit margins for those positions. And we don’t want these margins to disappear into a black hole of bitcoin debt left by overly speculative investors.

Given the current volatility of the bitcoin and the extraordinary risks involved in this market, we regard the margin requirements for the bitcoin futures of both these exchanges as insufficient. We have expressed our concerns on this topic to both exchanges, asking them to raise these margins and/or to take other measures to ensure that the risks involved with trading bitcoin futures will be contained to those investors choosing to trade these futures.

The risks involved with trading bitcoins should be contained to those who choose to trade them.

Responsible investing

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We support innovation in financial markets, where new products will develop in response to society’s changing needs. Futures markets are excellent places for price discovery, as well as for transferring risk between parties. We have regularly been among the first investment managers trading such new markets. And we do not exclude the possibility that the circumstances around bitcoin will change such that we might find the conditions right for trading bitcoin futures in our programs as well. But that will not change our opinion that the margins for bitcoin futures need to be commensurate with the risk that they represent. We have never been in favor of clearing houses setting low margin requirements, especially not when this is done for competitive reasons. We believe that margins should always be sufficient to cover the risks involved in a specific market, irrespective of whether we ourselves trade that particular market or not. 


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