Rough Trades: Digital Derivatives Hit the Bitcoin Markets as Wall Street Bankers Take Interest

 

THE BEST WAY TO FIND serious traders of the digital currency Bitcoin is to log onto Internet Relay Chat—that bare-bones, plain-text experience that hasn’t changed much since its creation in 1988—around midnight, and jump into one of the many conversations dedicated to the phenomenon. Bitcoin, a decentralized payment system that approximates cash, has been quickly gaining popularity since May, when its bit part in a Gawker story about an “underground website where you can buy any drug imaginable“ turned into a starring role in stories like Fast Company’s “Funny Money: Is Bitcoin the Future of Currency … Or a Total Scam?”

One indication of how far the currency has evolved: the emergence of Bitcoin derivatives. Despite reluctance by merchants to embrace the new money and a near-constant stream of crises, from cyberattacks to technical failures, the two-and-a-half-year-old technology—carefully designed by a group of anonymous programmers to serve as a standard for digital payments without the need for a central authority—seems to have staying power. This is especially true among its investors, who have graduated from simple transactions like buying and selling to negotiating options and futures contracts.

On Sunday night, Betabeat blundered into #bitcoin-pit, an IRC channel “for professional trading,” and found a surprising number of Wall Street professionals, including “Bill,” who declined to give his name but proved his employment the next day with a furtive call from an empty conference room at Credit Suisse. He had just sold 400 Bitcoins, he told Betabeat, which he planned to buy back in the morning. Given that the third-largest Bitcoin exchange, Bitomat.pl, had just accidentally deleted the 17,000 BTC it had in deposits at the same time another popular Bitcoin service shut down—possibly because its owner decided it was time to take the money and run—Bill was betting the price would be right.

“Bitcoin is like Wall Street was 15 to 20 years ago when I entered,” he said. “Fragmented markets, wide spreads, manipulation, the trading stone ages.”

So far, the major Bitcoin exchanges have stuck to buying and selling, which takes much of the fun out of playing the market, as it limits traders’ ability to bet and hedge on the future. “You can’t put in a stop order, you can’t do short sales,” Bill said. “You can’t do more sophisticated strategies.” But Bitcoin finance has come a long way since Bill first bought 150 BTC in December at $.24, transferring money into the Chase bank account of the original founder of a website called Mt. Gox, now the largest Bitcoin exchange. On Monday, Mt. Gox traded more than 20,000 Bitcoins at $13.1, or about $290,000 worth. It now supports a variety of electronic payment methods as well as checks, European bank transfers and international and domestic wire transfers, not to mention cash.

The number of exchanges facilitating trades of Bitcoins for U.S. dollars, euros, yen, even Chilean pesos, is also proliferating. Ruxum, founded by a former Citigroup vice president, and CampBX, based in an actual brick-and mortar office in Atlanta, both launched this month. And exchanges are just the beginning. Bitcoin-related start-ups trade shares denominated in Bitcoins via the Global Bitcoin Stock Exchange. There are escrow services for Bitcoin traders and sites that rely on user-submitted reviews to approximate ratings agencies. There are intermediaries for intermediaries, such as BitInstant, a brand-new start-up based in New York that offers credit to traders so trades can execute faster.

Just as the first phase of Bitcoin was dominated by nerds and hackers attracted to the technology, the second is being shaped by finance professionals fascinated by the new market.

“I sold a put on #bitcoin-otc a few months ago,” Bill said. The buyer was afraid the price was going to fall below a dollar within a week; Bill thought it would stay above $6.50. He was right. “I collected the premium and it never went in the money,” he said, using the Wall Street slang for when an option can be profitably executed.

“There’s so much polarization among the people who are familiar with this project, that out of any 10 people you may have five of them who think it’s going to change the world and five of them who think its a scam or pyramid scheme and that it’s going to collapse,” he explained. “Therefore, both those groups would like to trade options.”

Mt. Gox, based in Japan, and its month-old competitor TradeHill, based in Chile, both say they plan to offer margin trading to give smaller sellers extra leverage, and options so traders can hedge. “I have a colleague advising us who was the head of software development for Interactive Brokers,” said TradeHill co-founder Adam Stradling, who consulted for five years on Wall Street, studying offshore investment, derivatives, credit, debit and other risk analysis and is now working toward his Certificate in Quantitative Analysis. “He actually runs an entire country for Interactive Brokers, wrote all the code for shorting and margin and a lot of this stuff.”

TradeHill has four or five clients that Mr. Stradling believes are connected to boutique hedge funds in New York, he said, who have executed single trades as large as $10,000. “This would give them more features to trade better,” he said. “If they could short the market, or if options allow them to take positions in different ways and also hedge risks … it’s really just evolving the features to look like more traditional trading.”

Bitoption, an exchange exclusively for derivatives, appeared briefly last week before its developers took it down to work out bugs. But CampBX founder Keyur Mithawala, whose background is in information security, is confident that within two months his exchange will become the first to offer short selling. The three-week-old exchange enabled margin trading and short selling during its trial period, he said, but disabled it after launch because there weren’t enough deposits. “This is not a brag, but we’ve been able to make it so all you need to do is enter price, enter quantity and that’s it,” he said.

Derivatives trading could go a long way in boosting the adoption rate among merchants, who would be more likely to use the jumpy currency if they could lock in prices with forward contracts. But adding complex financial instruments to a completely unregulated economy seems questionable, especially considering the fate of Bitomat.pl, which accidentally destroyed $222,700 worth of Bitcoins over the weekend. “Holy crap, that is crazy,” Boston-based software developer and Bitcoin enthusiast Alex Spitzer said when Betabeat asked him what had happened. “It’s like if I set up the Bank of America site on my home computer and forgot to back it up, and then rebuilt my machine,” he explained. “The problem with the Internet is that it is easy to make something look legitimate even if it is running with duct tape and twine.”

Buyers, beware. Bitcoin seems to be attracting traders with just enough knowledge to be dangerous. Betabeat’s office happens to be 10 blocks south of Meze Grill, a Mediterranean lunch spot on Eighth Avenue that recently started selling Bitcoins in addition to tasty salads and nutritious smoothies. So on Thursday we pooled $90 from coworkers and schlepped uptown in the heat to purchase a modest six BTC for research purposes. As advised, we used MyBitcoin.com, a popular Bitcoin “wallet” based in St. Kitts and Nevis, to transact the deal.

On Friday, MyBitcoin disappeared from the Internet with no explanation, taking our investment with it.

We sought answers in the #bitcoin-otc web chat. “I think they ran away with the Bitcoins,” someone known as Nanotube replied, softening the blow with a smiley face. Nanotube administers the IRC channel as well as bitcoin-otc.com, the most well-known forum for person-to-person Bitcoin trades; he’s working on a Ph.D in finance, he told Betabeat. “Maybe the owner is just on vacation, and the site went down … But if I had to bet, I’d bet you’ll never see your coins again.”

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