The Crypto Conspiracy

A theory has been circulating that attributes the current cryptocurrency carnage on hedge fund involvement and the recent start of bitcoin futures contract trading. I previously described a similar plan for market manipulation at the end of my article, the Bit Short. I doubt that this alone could explain the steep dive in the price of all major cryptocurrencies. Short-sellers and day traders make money from the up and down gyrations of an asset, not by breaking the market and sending the small-time investors running. I think bigger forces are at play here.

In my follow-up article, the Bit Run I listed out various news reports that indicated that restrictions on cryptocurrencies were coming into force in various different jurisdictions around the globe, the key one being South Korea.

It’s almost inconceivable to think that South Korea and its citizens have allowed themselves to get so involved in cryptocurrency, knowing that their nuclear-tipped neighbour, North Korea is known to actively dabble in the currencies. Even if you discount the hackings, ransoms and mining, simply letting South Koreans buy and hold cryptocurrency increases the value of the hoard that North Korea is known to have already accumulated! Despite all the sanctions imposed, the South and its allies have inadvertently been funding the North’s nuclear program through cryptocurrencies. This is why the current clamp-down makes sense.

It not new for governments to intervene in markets tied to politically sensitive situations. While it is not irrefutably proven as market manipulation, the sudden drop in the oil price from US$147 down to sit for a prolonged period at around US$40 played a critical part in the ultimate defeat of the Islamic State. Much of the terrorist group’s funding at their peak came from the smuggling of oil produced from captured territories. Victory over IS was declared only last December and suddenly oil is now back up to $70. While OPEC might control the supply of much of the oil to global markets, pricing is negotiated among the market makers, commodities trading desks and futures contract traders in the financial centres of the world. With Islamic State at their doorstep, convincing many OPEC members to co-operate would not have been difficult.

It’s not hard to imagine that South Korea, the US and their allies are going to start targeting cryptocurrencies as a potential funding source for North Korea’s nuclear program. Nuclear war is a significantly larger threat than a ideological jihad ever was. I expect the downturn in prices to continue for a prolonged period, at the very least until the situation with North Korea is diffused.

 

The Bit Short

tether-blog

What does a bank run look like in a world without banks? For an industry that on the surface has all the hallmarks of finance, the world of cryptocurrencies is increasingly growing devoid of banks. If you read my diary of a cryptocurrency investor, this is part two; a behind the scenes analysis on how hobbyist support of Storj and Ethereum was inadvertently parlayed into more than 11x gains in real world value.

Like everyone else, at the time I chalked it up to the increasingly mainstream adoption of Bitcoin and other cryptocurrencies. Ethereum was becoming a platform for startup funding via Initial Coin Offerings (ICOs) and was drawing increasing media attention, and with it money. Yet six months on, and cryptocurrency prices continue to rise, despite the ICO craze waning, and an increasing number of people calling “bubble”.

The follow up to my original story began with a recent article published on a hack of a cryptocurrency service called Tether. I would describe Tether as operating similar to a cyber central bank. They take deposits of USD and issue their own US dollar backed tokens, Tethers (USDT). You can take these Tethers to various cryptocurrency exchanges and convert them with much more ease than moving actual US dollars. Within the cryptocurrency circles, Tethers are becoming a convenient safe haven in times of volatility as their value is engineered to be “pegged” against the US dollar. In the hack, $31 million USD is lifted from the Tether treasury, and the company brushes this off casually. In fact, in the following weeks the service continued to issue millions more Tethers.

Suspicious of this activity, I spent a weekend reacquainting myself with the latest news in the world of cryptocurrencies. One online persona, bitfinexed, has compiled a laundry list on Tether, its sister company Bitfinex, and the characters that pull their strings. I’ve been a supporter of cryptocurrencies since 2015, and the transpiring events are gravely concerning. Transposing the events around Tether against my own experiences, I believe that Tether is single-handedly driving the rise in Bitcoin’s price and renewed interest in other alternative cryptocurrencies. Tether appears to be injecting millions of US dollar Tethers (potentially unbacked) into exchanges around the world.

Around March of this year, Bitfinex began reporting problems with their real world banking arrangements. By June, Tether was issuing USDT at a quickening pace. It was around this time that I began selling down my positions in Storj and Ethereum because I couldn’t make sense of the price rises. Both these alternative cryptocurrencies are small players compared to Bitcoin. Their markets have low liquidity and are based around very small trades, which make them easy to manipulate by a well financed trader. Wash trading is often possible at exchanges, which allows traders to buy and sell to themselves at increasingly higher prices to “ramp” up the price in a bid to draw in unwitting investors. In my own experience around that time, it seemed like the market for Storj showed symptoms of this and my actions to progressively sell down my large holdings temporarily put an end to this by intercepting wash trades with my own legitimate sell orders. By the time I had completed my sell down, the Storj market had declined to a lower but less volatile valuation.

Cut to November and Bitcoin is now worth five times as much as before, and the number of Tethers in circulation has ballooned to match. As the real world of finance increasingly distances itself from cryptcurrencies, Tether has stepped in to fill the gaps. It has become the bank of last resort for many bitcoin entrepreneurs, by providing a stable US dollar denominated store of value in an ecosystem full of constant volatility. It would appear that in the cyberscape of blockchains, there is so much faith in technology that trust in the people that run the systems no longer matters.

As long as these digital currencies remain in the realm of enthusiasts and hobbyists, there is no systemic risk to the global economy. In a closed system, Tether can print as much USDT as it likes without affecting real US dollar supply, foreign exchange or inflation rates. In fact, a virtual printing press like Tether might play a critical role in creating a sense of purpose in a deflationary system like Bitcoin, where a lack of inflation and slow adoption creates little incentive or opportunity to spend a Bitcoin. With much bigger asset bubble problems in the real world, governments and regulators have little time to tinker with Bitcoin or Tether.

The looming start of futures trading on Bitcoin only serves to further quarantine the world of cryptocurrencies. Contrary to what many amateur investors believe, futures markets do not draw institutional money into an asset class. Instead they serve to separate commodity pricing from speculative investing, by creating a playground of bets for and against the price of an asset without actually buying or selling the asset. Much like how  placing a $1 wager on a horse race doesn’t make your horse run any faster, a dollar going into the futures market will not go anywhere near a Bitcoin. Creating a futures market for Bitcoin could actually draw away any existing  institutional investors by creating an mechanism where they can wager on the future price of Bitcoin without ever purchasing, holding or selling a Bitcoin. Investing via futures contracts eliminates the costs and risks of holding Bitcoin directly. Nobody can hack and steal your futures contracts.

Ironically, instead of bringing money into the cryptocurrency ecosystem, a futures market might actually create the best opportunity to generate wealth off of the blockchain and into real world profit. As long as everyone continues to believe that every current and future USDT in circulation will be backed by a real US dollar, Tether can control the price of Bitcoin! The current Tether induced escalation in Bitcoin’s price could be preparation for a very large short contract on Bitcoin that would pay off handsomely in real US dollars if Bitcoin’s price were to suddenly collapse. Given the amount of USDT already spent in the last year buying Bitcoin to support its increasing price, it’s likely that Tether’s sister company, Bitfinex holds a significant quantity of Bitcoins. Whoever controls both Tether and Bitfinex can force Bitcoin’s price in either direction depending on the most profitable futures contracts placed on the market!

It’s sad to think that Bitcoin could become a swindler’s pendulum, milking profit from the futures market while counting down to the day authorities would be forced to intervene. If cryptocurrencies fail to gain legitimacy as a medium of exchange or a store of value, at least there will always be kittens.

UPDATE: It would seem that real world bankers are not sitting idly on the sidelines. They have lodged a protest against the start of the Bitcoin futures market and could severely limit client access to such markets.

UPDATE: Investigations into market manipulation are beginning with several exchanges being subpoenaed by the US Commodity Futures Trading Commission. There are also signs that a criminal investigation into Tether is in progress with the details of subpoenas previously handed to Tether being kept secret.

Related Articles:

https://www.bloomberg.com/news/articles/2017-11-21/bitcoin-falls-after-31-million-theft-of-cryptocurrency-tether

http://www.afr.com/markets/warning-is-bitcoins-biggest-exchange-unreliable-20171130-gzvvwy

https://www.bloomberg.com/news/articles/2017-12-05/mystery-shrouds-tether-and-its-links-to-biggest-bitcoin-exchange

https://medium.com/@bitfinexed

The Alt-Auction Clearance Rates

In my article the Tax Reform, I mentioned under-reporting of auction results as a possible reason behind the robust auction clearance rates often used to keep public sentiment about the property market in Australia buoyant.

In this AFR article, they mention the following:

Mr Christopher also said a downturn could be closer after observing a rise in unreported auctions in 2017 against the bumper level of 2015.

Last weekend about 25 per cent of auctions were unreported, while in 2015 – when the Sydney market was rising at its fastest rate in 30 years – about 18 per cent were unreported. That said, volumes of auctions were also about 10 per cent lower in 2015, making it easier for data to be collected.
“In life, there is a tendency to want to report good news but not so much the bad news,” he said.
“As such, when there is a rise in unreported rates it may suggest there is increasing bad news in the property market, notwithstanding any surge in listings which may make it difficult for auction reporting teams to compile the results before the day is out.”
Higher listings, while welcomed by real estate agents who need stock to meet demand, also suggested vendors might be pre-empting the market to be close to peak, Mr Christopher added.
Not surprising to see in an era of fake news and alternative facts.

Australian Property: The Crane Harvest

Abstract: An opinion piece on a possible key indicator of when the housing market downturn will no longer be deniable. Exploration of why the signal works and how different factor affect the Australian market.

***

I should begin by saying that this is a pure opinion piece. Nothing written here constitutes financial advice. I do not profess to have the investigative prowess of a journalist nor the professional credentials of an economist. I’m simply an avid observer and casual writer.

I recommend starting with the opening pieces; The Politics and The Welfare and The Financials.

The Crane Harvest

Given how vocal I am about the excesses of the Australian property market and the greed of the finance industry, recently I’ve been asked by several different people for a more exact prediction of when the crisis with unravel. Rather than repeat myself, below is a summary of several points conceptualised during these discussions.

Building cranes are currently a prominent fixture on any Australian capital city skyline. Working in a recently built and half-leased building in Brisbane’s outer CBD suburb of Newstead, I could glance through the glass wall along just one side of the building and count out 10 cranes; all working on what were colloquially known as “Chinese money laundries”. Commuters arriving at just about any station along main inner Sydney rail lines will be greeted by the gentle swaying of these apartment block placeholders. The massive construction effort happening at Olympic Park is worthy of its place name, with rows and rows of apartments rising up between the under-utilised ferry terminal and the still under-developed vestige of the Sydney 2000 Games.

My predictions are not unique. The same indicator has been referred to in the past. They are even used as a boom-time index by some economists. In recent history, an excess of building cranes heralded the start of the property crises in Ireland and Spain. As such it is concerning that last year, Australia’s population of 23 million managed to raise more building cranes than the 320 million Americans who support a significantly more generous migrant intake policy. This is why I believe they represent a prominent lay-man, yet accurate indicator of when the unthinkable will finally become the undeniable.

When a building is completed and its crane disappears, several different factors combine to produce a drag on the economy.

1. Construction workers will need to find new projects to work on. In the past the mining industry would be able to absorb these skill sets, however with oil, iron and coal prices still swinging low it is likely miners will still be contributing to this pool of jobless than helping to absorb it. Current estimates peg about 200,000 jobs (1.6% of the workforce) associated with the property industry. In a country where at least a third of the population is paying off their own home, a rise in unemployment will result in a directly proportional rise in mortgage stress, mortgage arrears and ultimately, foreclosures or forced sale.

2. Reselling of newly completed developments. This is the pivotal point where a projected oversupply becomes realised in a way that can materially affect market prices and clearance rates. It is also important to note that there is asymmetry between the new, off-the-plan market and the second-hand, established homes markets. Due to recent law changes, foreign investors are generally prohibited from buying establish homes. In the absence of foreign investors, any distressed new owners will be forced to sell into a property market more than half the size (& demand) as the one they competed to buy into. Some emerging websites are trying to facilitate apartment contract transfers prior to completion, however the concept is so new that the statistics on these transfers are either not available or not captured in official government figures (both number of sales and selling prices).

3. Settlement risk. Most off-the-plan purchases are secured using a deposit that is only about 10% of the contract price. Buyers have to secure an approval from a lender to loan the remainder when the home is built and contract settlement can happen. This approval is not binding, and can be re-assessed at settlement. A year or two later, the risk appetite of the lender may falter, the buyer’s circumstances may change, regulators may clamp down to reduce home/investor lending or the home may be revalued lower. In fact all of these things have happened in recent reported incidents. Settlement may fail if one or more of the above happens, and the buyer is forced to find an alternate lender (on short notice) to fully fund or contribute additional money towards the contract price. If the prospective buyer fails to do so, they lose the deposit and the developer is forced to find a new buyer. The deposit taken is sometimes used to discount the property to lure a quick purchase, which impacts market pricing and contributes to lower valuations on other similar properties.

4. An oversupply of rental vacancies. Assuming that not all these new homes will be bought as investments, there will be a sizable shift in Australia’s demographic from renters to home owners. This mass migration would vacate an equal volume of rental properties in a market that is already at low rental yields. Landlords with empty properties may choose to sell-up rather than continue to absorb the on-going expenses, thus adding further to the market oversupply. This effect could be amplified in a positive feedback loop if lower prices facilitates even more home ownership, resulting in more vacant loss-making rental homes being sold at even lower prices, further increasing the affordability of home ownership.

Multiply these negative impacts against the 528 cranes working on the east coast and it is clear the Australian economy will face significant challenges when these building sites reach completion. It may already be too late for existing investors to exit the market. Declining building approvals marks the beginning of a decline in crane numbers. The point at which the crane harvest ends may very well be when what was sown is reaped. For the remainder, my only advice is to act prudently; plow your income into savings, fallow the downturn and think ahead towards the next planting season.

http://www.abc.net.au/news/2016-10-21/real-estate-warning-more-cranes-in-australia-than-us/7954108

http://www.abc.net.au/news/2016-10-20/200k-jobs-at-risk-as-housing-boom-rolls-over:-morgan-stanley/7952478

http://www.smh.com.au/money/property-price-boom-masks-risks-for-investors-as-yields-plummet-20170206-gu6av1.html

http://www.abc.net.au/news/2016-08-11/rise-in-australians-not-keeping-up-with-mortgage-payments/7722110

http://www.abc.net.au/news/2016-10-19/mortgage-delinquencies-hit-record-levels-in-two-states-and-nt/7946056

Australian Property: The Tax Reform

Abstract: An opinion piece on the recent discussions on proposed changes to negative gearing laws in Australia and why now is the time for reform. The first article in a series that explores why negative gearing creates a distortion in the market and will continue to explore the potential impact and pros/cons of each proposed change.

***

I should begin by saying that this is a pure opinion piece. Nothing written here constitutes financial advice. I do not profess to have the investigative prowess of a journalist nor the professional credentials of an economist. I’m simply an avid observer and casual writer.

I recommend starting with the opening pieces; The Politics and The Welfare and The Financials.

The Tax Reform

Given my previous writings on The Welfare, it is no surprise I am going to comment on the recent news on possible changes to negative gearing. I’ll start with some personal thoughts and if I find the time I may dissect the merits of proposals put forward in later posts.

I should state that I do not write political opinion pieces. It would be an objective analysis of the proposals put forward so far by both parties. Fact is that policies promised on an election year are not always the same policies legislated by an elected government.

In all honesty, I did not expect such a swift attack to the heart of the dysfunction in the Australian property market. I’m just as shocked as the real estate industry, and equally alarmed at what such a direct blow might do in a global era of low growth. However, bipartisan support for a review into negative gearing almost guarantee that changes are coming and new legislation tends to have an immediate effect on any impacted market or industry.

It is important that the government tackle tax leaks like this in any attempt to fix the budget. If the government were to simply raise taxes on everyone without patching up the deductions loophole, they would be creating a stronger incentive for those with the means to pursue more negative geared investments to escape the tax hike. Not only would the tax rise fail to raise the projected revenue, but the increased competition to find properties suitable for tax avoidance would exacerbate an already overheating property market. Unlike the other great tax avoidance scheme, voluntary superannuation contributions, income tax deductions have never had a limit.

The property industry has not been lucky in recent years. It isn’t just changes to negative gearing that threaten their continued success. A potential reduction of the capital gains tax discount on investment properties has been suggested. New rules around the significant investor visa direct foreign money into small capitalisation stocks and venture capital firms. Stricter policing of illegal property purchases by foreigners lead to forced sales. Potential ratification of the extradition treaty with China could facilitate a great repatriation of billions of dollars of criminal proceeds from fleeing corrupt officials & disgraced business men. Repeated regulator intervention to force banks to tighten mortgage lending to investors. The industry is so besieged that they have taken aggressive action to protect their interests. Their lobbying groups have resorted to thinly veiled threats such as tabulating the number of negatively geared investors in marginally held MP seats. Much like the attacks on the mining tax, expect TV advertising campaigns to be aired to marshal public outcry at any proposed changes.

How exactly did the darling of the weakening Australian economy fall so quickly from grace? Maybe the powers that be have already divested their property interests? By the time a bubble peaks, the smart money has long since left. Are they unable to financially support the same level of lobbying influence? Despite what the mainstream media reports, the property industry may already be in a down turn.

In recent years, much of the news reporting around the growth of Australian house prices has moved away from government collected statistics. Nowadays, the preferred health indicator for the market is auction clearance rates. It isn’t often publicised that this data is based off voluntary submissions from real estate agents, which make the figures highly malleable and harder to police. Those with a conflict of interest can choose to omit passed-in/failed auctions in a bid to avoid further dampening buyer sentiment. Smart agents may even cancel an auction or recommend a private treaty sale if interest in the area is low. Auctions are also more prevalent in city centres where demand is always buoyant, and hence these numbers do not reflect the state of the market in suburban or regional areas.

While it is encouraging to see open debate on the issue of negative gearing, many signs indicate that change is arriving too late. Australians are already the most leveraged households in the world, and the resulting financial hardship is rife with one in two reported to be living payday to payday. Casualties are already emerging with one couple left stranded in $3.5 million of debt. Chasing the great Australian dream, may just be exactly that and many may be in for a rude awakening.

 

http://www.afr.com/news/politics/negative-gearing-four-graphs-that-show-it-is-mostly-for-the-rich-20160214-gmu2vu

http://www.abc.net.au/news/2015-05-12/janda-why-negative-gearing-tax-benefit-should-stay,-for-now/6461040

http://www.smh.com.au/business/the-economy/australian-households-awash-with-debt-barclays-20150315-1lzyz4.html

http://www.abc.net.au/news/2016-02-15/many-australians-living-payday-to-payday/7167350

http://www.afr.com/news/property-lobby-threatens-mps-over-negative-gearing-20160203-gmlaz3

http://www.afr.com/real-estate/home-buyers-in-outer-sydney-should-be-very-cautious-says-20151117-gl162b

http://www.afr.com/news/world/asia/a-short-history-of-illicit-chinese-funds-in-australia-20160126-gmebq2

http://www.katemoloney.com/#!about-kate/c1mv6

Wet Tinder

If Tinder (the App) is so useful at matching boys and girls, then why do it’s users keep using it? Why do they keep looking for more dates? I would have thought couples would no longer have a need for Tinder.

In the startup world, repeat customers and user activity is a measure for target audience engagement and long term appeal of a website or app. The more addicted users are to your solution, the more they promote it and the less likely they will be to leave. With a bit of luck this leads to exponential growth, and with it valuations. The stuff entrepreneurs have wet dreams about. In theory, the better you are at solving your user’s problems, the more attached they will be to your product and they will keep coming back for more. In the world of match-making software, if Tinder was so successful at finding your perfect partner, it would effectively put itself out of business in a few years. It would have no repeat customers, and at best only referrals. It would be a billion dollar flash in a pan.

I had this eureka moment discussing dating over well, a date. The topic came up as my date’s workmates were all jumping on board and raving about it. I will admit it is a great new way to socialise and you’ll encounter many different types of people. How effective it is at connecting like minded, life partners is yet to be determined. In a sense this means Tinder is about as effective at relationships as wet kindling.

I guess the app addresses a different problem to the one it advertises to solve. Rather than fulfilling a promise to find love, it seems to be a better platform for flirting, attention seeking and random encounters. All of which lend themselves well to returning customers.

The Online Line

Despite the promises of online technology, we are increasingly spending more time waiting. You may not see the line but it’s there in the wires that run the internet.

I hate waiting in line. Banks, supermarkets, ticket booths, help-line hold queues; so much time is lost at these places. The technology, especially the internet promised to make this obsolete. It would be the age of self-service. We would all be empowered to do business ourselves instead of waiting for our turn to talk to a company representative who would push buttons for us.

For a while this was true. Web retailing took off and so did online banking. Customer portals popped up that let you edit your details, search for information yourself or do your own business. Productivity rose and it felt like we could do more on this platform. So we did. Social networking, event organisation, messaging, navigation, word processing, television, radio… there was nothing we couldn’t put on the web.

Today the realisation hit me, while I was watching a spinner on Facebook. We are still waiting, maybe more so than ever. I’m waiting for video rentals to download, websites to render, messages to send, social pictures to load, online games to sync & documents to save to the cloud. Progress bars have developed such a negative reputation for both unreliability and irritability that designers have often opted for the less-functional spinner icons.

The immediate problem is infrastructure. Bottle necks in bandwidth, under powered servers, and legacy technology that simply was never designed to scale to global levels. Things were fast when it was only the early adopters, but now that the adoption rate has increased the speed of service will go down. The simplest of fixes would be to build more and faster servers to process the increasing number of requests. The fundamental problem is that we never eliminated the queue, we just replaced a human representative with a lighting fast digital one. Even lighting takes time, and as millions more people join the queue, expect wait times to increase.

What has the potential to makes it worse, is that in a bid to shift from a pirate-able product offering to a stable revenue generating service model, we’ve introduced more queues to the world. Television and radio worked on a broadcast model. Everyone would get the same signal at the same time. Now if you want to watch a TV show on your mobile, you would have to send a request to a server which would then process it by streaming the video data back to your phone. Rather than serving millions of customers at the same time, the broadcaster is serving each of you one at a time.

Who am I to stand in the way of progress. I love the internet. After all, this blog post is hosted on the internet. I just believe that a paradigm shift is required to truly address the scalability problems the internet faces.