Streetwise Professor

April 13, 2013

Was the Bitcoin Flock Just Sheared?

Filed under: Economics,Regulation — The Professor @ 9:01 pm

The virtual “currency” Bitcoin has been much in the news lately, due to its meteoric rise in price, and even more precipitous drop.  The price rose from approximately $40 in early-March to $266, then plummeted to as low as $54 in the course of a couple of days.

Most of the commentary has been a colloquy between true believers (including anarcho-capitalists, self-styled Austrians, etc.) and more mainstream skeptics.  The true believers say things like “Bitcoin is the most important invention ever” and wax eloquent (and ecstatic) over its liberating potential.  The skeptics point out the various practical limitations, which are quite acute.

Count me as in the skeptic camp, but that’s not what I will address in that post.  Instead, I will focus on the rise and fall in the price over the past month (which has been the second BitBubble-there was also a less severe one in 2011).   What surprises me is that I have yet to see anyone suggest what appear to be an obvious possibility: that the bubble is the result of a pump and dump scheme.

The price movement-a rocketing rise followed by an even more rapid fall-is the classic pump-and-dump pattern.  Moreover, all of the ingredients are there, just like in a penny stock.  An asset traded in a very thin market. A group of cultish true believers in the transformative nature of what they have invested in.  Moreover, this cult has clear doomsday predilections, especially where money is involved, and the events in Cyprus were calculated to stoke paranoia.

All of this is tailor-made for an operator or operators to start a stampede into the currency, and then puke out their Bitcoin at the top.

And there are operators-speculators, if you will-in Bitcoin.  Last week, several stories ran about the Winkelvoss twins’ (of Facebook fame/infamy) speculative investment in Bitcoin.  No, I am not accusing the twins of running a pump-and-dump.  I just bring them up to point out that BTC has attracted a speculative element.  And no doubt some of this type views the bleating Bitcoin flock as primed for shearing.

If it is a pump-and-dump, several questions arise.  One, obviously, is who done it?  Another: where are they located?  Were the laws of any country violated?  (Bitcoin aren’t securities, I don’t think.  Are they commodities, as defined by the Commodity Exchange Act?  That seems quite plausible.)  How much money was lost?  (This would depend on the volume of trade on the various Bitcoin exchanges during the Rise and Fall of the Bitcoin Empire.) I haven’t been able to find any indication that the CFTC has taken interest in this, but given it’s long-running campaign against FX boiler rooms, and bucket shops (to which the various Bitcoin “exchanges” bear more than a passing resemblance) it would seem to be a natural.

To me, the Bitcoin drama of the past weeks seems to be a penny stock manipulation scheme writ large.  What comes of that is quite uncetain, given the virtual nature of Bitcoin and the fact that it is traded at “exchanges” around the world.  These facts mean that it could fall between the regulatory and legal cracks.  To many Bitcoin Believers, that’s a feature not a bug, though one wonders if they will reconsider that if they bought at the top.

Returning to Deep Thinking About Bitcoin, I can’t resist mentioning this Krugman piece.  Paulie Krugnuts appeals to authority, namely Adam Smith, in his critique.  Smith’s analysis of gold and silver is correct, and applicable to Bitcoin, but I find it somewhat amusing that Krugman defers to the Great Scot.  Would that he would  do so more regularly, and on more important matters.  His commentary would improve immeasurably as a result.

This brings to mind a story that George Stigler told.  He used to bet his grandchildren $1 million if they could answer three questions correctly.  (He said something to the effect that eventually the Federal Reserve would make it possible for him to pay off that bet in the event his grandchildren won.  And he may well be right on that, and in the not too distant future.)  The first two questions were trivial, like “what color is the sky?”  The third was the stumper: “Who was Adam Smith’s best friend?”  Then one day his granddaughter said: “You are, grandpa.”  That was probably the correct answer, but it is mind-bending to think of Krugman as vying for that distinction.  Anyways, I hope that Krugman makes a habit of asking “WWASD?” before unburdening himself in the future.  He would be doing the world a favor, and spare himself of much embarrassment.  Assuming, of course, that he is capable of it.

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  1. Seems more likely than the other theory I heard that this is a DEA scheme to smoke out Dread Pirate Roberts. Bitcoin sure has a cast of characters.

    Comment by pahoben — April 14, 2013 @ 4:36 pm

  2. David Hume, yeah?

    Where do I make my claim against Stigler’s estate?

    Comment by Regulator on lunch break — April 14, 2013 @ 10:15 pm

  3. […] have seen comments on random blogs wondering about Bitcoin, and I have avoided writing about it.  But Craig Pirrong did, and I think he sums it up really well. focus on the rise and fall in the price over the past […]

    Pingback by Bitcoin Bubble, Sign of Irrational Markets? - Points and Figures | Points and Figures — April 15, 2013 @ 6:26 am

  4. Dread Pirate’s reported accumulation of 500,000+ Bitcoins would have been exchangable for $130,000,000+ at the peak. Plenty of money to follow.

    Comment by pahoben — April 15, 2013 @ 7:39 am

  5. Multi amputee vets and crippled children now will have even tougher sledding at DHS checkpoints and seeing Elizabeth Warren on the dais was at best nauseating.

    The unwillingness of Obama and others to provide any details at all is fully consistent with a jihadi attack.

    Comment by pahoben — April 15, 2013 @ 10:03 pm

  6. Prof.,

    Being one who flirts with the An-Cap ideology, I’ve been passively following the recent news relating to BitCoin. However, in what I’ve read, I too remain a skeptic. That being said, I don’t think last week’s crash had anything to do with BitCoin being cornered in a “pump-and-dump” scheme. Rather, it was a distributed denial of service (DDoS) attack that shut down trading and then scared off investors. If you’re unfamiliar with a DDoS, it’s a hacking technique whereby a hacker (or group of hackers) shut down a website by flooding that website’s server with traffic, i.e. the hacker(s) simultaneously tries to access the website from a very large number of IP address. The website’s server cannot handle the traffic so it shuts down. The website that was attacked was “Mt. Gox” which handles 60-70% of BitCoin’s transactions.

    Of course, BitCoin is trying to play this off as a too-much-of-a-good-thing story. They say that it wasn’t hackers or speculators, rather that the recent spike in BitCoin users, which generated the meteoric rise prices, also caused the crash as the server capacity was unable keep pace with the additional traffic. It’s a plausible scenario. They go on to say that these types of things are merely growing pains and that server capacity will soon catch up. One benefit of the BitCoin market is that anyone can turn their home computer in to a server capable of processing transactions. Indeed, BitCoin is already the largest “distributed computing” project in the world in terms of hash power.

    So was it a classical pump-and-dump scheme on a penny stock? Well let’s not forget that a month ago, before all this hysteria, the exchange rate $/BTC was $47. It’s not $800 Google but with prices like that it wouldn’t be easy for someone to manipulate the market.

    Or was it a purely technical issue driven by a structural increase in demand? Either way BitCoin wont survive unless it grows out of these issues.

    Here are my concerns with BitCoin:
    1. They say the government cannot confiscate it from you because you do not need a financial intermediary to process transactions. Well, if the BitCoin becomes viable, I can promise you the government will find a way to tax it.

    2. If I am paid in dollars and I wish to buy things in BitCoins then you introduce the added uncertainty from the exchange rate and that added transactions costs from constantly exchanging currencies. This is one reason for the Euro.

    3. I’m a monetarist. (I told you I only flirted with Anarchism) I think manipulation of the money supply can do good things for the economy if done properly. As I understand it, one of the guiding principles of BitCoin is a fixed money supply. How can BitCoin be used to affect real economic outcomes?

    See you in class.

    Comment by Jake — April 16, 2013 @ 2:07 pm

  7. SWP,why propose a “fradulent” pump and dump scheme, when the history of world is full of speculative price swings that are simply due to genuine (and admirable) human behavior. Entrepreneurs are valuable exactly for their risk-taking, optimistic behavior. Thinly trades items (short supply) are particularly prone to massive price swings, which may be a necessary condition, but “fraudulent nature” is not necessary, nor is it the most likely scenario. Think of all the nutters out there hoping for a private currency- divorced from the coercive power of the state. They live in a state of constant denial and unsatisfied lust. Why would they not express themselves with a buying frenzy. And the more rational people who owned some bitcoins years ago, decided to sell a few and cover their cost of less than $1. Compare a young startup companies which does not have a transparent, tick-by-tick price like bitcoin, you would see the same massive swings in price, printing 10 cents one day, and $200 the next. Perfectly natural, and admirable human behavior.

    Comment by scott — April 17, 2013 @ 12:03 am

  8. […] Was the Bitcoin Flock Just Sheared? […]

    Pingback by Was the Bitcoin Flock Just Sheared? | Betteridge’s Law — April 19, 2013 @ 4:19 am

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