The crypto space was thrown into chaos today as the price of bitcoin and its peers plunged overnight, cementing the pioneering digital currency’s worst week since December 2013, only to rebound dramatically into the close, wiping out virtually all losses. Early today, just as the rout was nearing its trough, we shared a story from the Wall Street Journal about a mystery trader who placed a $1 million bet that bitcoin will climb to $50,000 by December 28, 2018.
That trade was a call option purchased on the LedgerX platform, which received permission from the CFTC over the summer to launch the first swap execution facility for the clearing of bitcoin-linked derivatives, and began trading in the fall, before CME and CBOE launched their own bitcoin futures. As the WSJ detailed previously, if bitcoin is below $50,000 on Dec. 28, 2018, the options will expire worthless, and the $1 million will be lost. But if bitcoin rises above that level, the options give their owners the right to buy 275 bitcoins for $50,000 apiece—a transaction that would cost about $13.8 million.
Some more details on the trade from AQR’s Aaron Brown:
… one or more people delivered 275 bitcoin (valued at $4.5 million at the time) to the LedgerX clearinghouse, and wrote one-year calls at a strike of $50,000 ($13.75 million in total) against them for a premium of $3,600 per coin ($990,000 total); that is, the buyer paid the seller $990,000 today, and has the right but not the obligation to buy 275 bitcoin for $13.75 million any time before December 28, 2018. These 275 bitcoin are held by the LedgerX clearinghouse and will be released on Dec. 28, 2018 to either the buyer (if the buyer exercises the option by paying $13.75 million) or the seller (if the buyer does not exercise).
These are real bitcoin, and there is no need for any sort of settlement auction, the call option buyer can exercise and receive the physical bitcoin.
Naturally, it was unclear who the buyer of the call was, just as it was unclear if the call was a standalone trade or part of a broader, multi-leg option strategy. And perhaps more importantly, was the identity of the seller.
On Friday afternoon, one part of the the mystery was solved, when the buyer of the $50,000 call was revealed as Blocktower Capital, a prominent crypto hedge fund, Business Insider reported.
BlockTower Capital is among the best known crypto hedge funds in a booming space that now includes over 175 such firms, according to fintech analytics firm Autonomous NEXT. BlockTower was founded by Ari Paul, formerly of trading firm Susquehanna, and Matthew Goetz, a former VP at Goldman Sachs.
Paul tweeted about the WSJ story on Thursday:
I wonder who bought these? ???? https://t.co/gIXFW0d0hm
— Ari Paul (@AriDavidPaul) December 21, 2017
Paul followed up that tweet by saying: “One thing to understand with options: a deep out of the money call is not a bet that something *will* happen, it’s a bet that something *might* happen. Risk a little to win a lot.”
Just days after the trade was executed, Blocktower is nursing a not insiginificant amount of bruises, because as a result of today’s sharp repricing lower in cryptos and the acute impact of gamma and vega on what is already the world’s most volatilte instrument (excluding electricity) the MTM value of the call option declined substantially (although in all fairness should today’s sharp rebound continue for a few more days, all the losses will be offset by the renewed upward momentum). Indeed, some like Dan Novaes, CEO of blockchain company Current Media said, “The holidays are a notorious time for crypto prices to drop — that has been the case over the past several years. After the holidays, I expect the prices to rebound.”
Perhaps Novaes is right: many have suggested that today’s drop was nothing more than some tax loss selling which quickly snowballed on Thursday night into a major momentum-reversal drop in the illiquid pre-Christmas market. And perhaps bitcoin will indeed trade well above $50,000 before December 28, 2018, resulting in a substantial payday for Blocktower Capital.
And while we know who the buyer was, what is more interesting here is the identity of the seller, as that may have been one of the original bitcoin “whale” billionaires, who – as Aaron Brown speculated yesterday – has found a way to cash out partially of their massive positions without moving the market.
Keep in mind that the only cash that exchanged hands when the trade was done was $1 million, or rather $990,000, between the buyer of the call, and the seller. Here is Brown’s explanation why this particular option trade could be far more important not for directional bet on the underlying, but to allow the mega holders of bitcoin to cash out.
I spoke to some large bitcoin holders, most of whom have held for years and never sold, and all expressed at least some interest in doing similar trades. It is a natural one, the “bitcoin billionaires” — the approximately 1,000 people who hold an estimated 40 percent of all bitcoin, or an average of around $350 million each — reducing their exposure in return for some cash today. In turn, financial investors get a secure, levered exposure to bitcoin that is not hostage to an unproven price-setting and without the expense of setting up a system to hold physical bitcoin. Bitcoin miners need cash for equipment and electricity bills (China this year cut off lending on bitcoin collateral) and early bitcoin adopters could stand to diversify their portfolios.
In addition to allowing whales to cash out in dribs and drabs, such selling of calls (or puts) could also have a dramatically stabilizing effect on the market:
One trade doesn’t make a market, but if, say, 1 percent of all bitcoin were taken off the market and held as option collateral, and financial investors put up cash in one-year derivatives, that could do a lot to stabilize the market. That means both reducing price volatility and giving confidence that market prices represent true trading prices for institutional quantities of bitcoin. This, in turn, could make Cboe and CME cash-settled futures more attractive, and thereby represent a solid base for bitcoin ETFs.
Finally, this increased visibility in the bitcoin pipeline and clearance would boost institutional confidence and lead to increased holdings:
And once that happens, institutions are likely to accept custodianed ownership of physical bitcoin, broadening and deepening the ownership base. There are few entities with institutional access to bitcoin derivatives trading and expertise with trading and holding physical bitcoin. That has to change for bitcoin to join the global financial system.
The last point is spot on because the inverse is also true: if bitcoin billionaires stay out of the market, institutional investment in bitcoin will remain problematic. Individuals will be able to trade small amounts in a fragmented market of loosely regulated exchanges, but futures and ETFs will not be securely backed by physical bitcoin — their prices will be pushed around by betting sentiment of people who own no bitcoin.
Then again, as Brown concedes “that’s not necessarily a bad thing. After all, bitcoin was invented as an alternative to financial markets, and it functioned quite nicely for years with no connection to Wall Street. That’s one possible path for cryptocurrencies, a parallel financial system. But many people have set their hearts on linking the two systems, and we may have just seen the first trade to validate their dreams.”
Needless to say, for Blocktower Capital’s bullish bet to be successful, a linkage which enables institutional investors to offload some of the “whale” holdings while stabilizing the market, would be the far better, not to mention profitable outcome, one which could indeed result in Bitcoin rising to $50,000, and above, in 12 months time.
Incidentally, Ari Paul is not worried by today’s selloff. In fact, as he tweeted earlier, “a major sell-off with prolonged consolidation at a lower level would be the healthiest thing for crypto. <50 million people own any at all today. I'd love to see broader ownership."