Hedge Funds Prepare to Trade Against Bitcoin

A bitcoin big short is building.

The planned introduction of bitcoin futures contracts at CME Group Inc., Cboe Global Markets Inc. and Nasdaq Inc. will make it much easier to bet on a decline. Hedge funds, which have largely stayed on the sidelines, are waiting for the Chicago Mercantile Exchange’s futures market to open for a fresh opportunity to bet against the cryptocurrency, according to more than a half dozen people trading the assets.

“The futures reduce the frictions of going short more than they do of going long, so it’s probably net bearish,” said Craig Pirrong, a business professor at the University of Houston. “Having this instrument that makes it easier to short might keep the bitcoin price a little closer to reality.”

Bitcoin has gained millions of percent since it started trading in 2010. An investment of $1 at the beginning would now be valued at more than $1.4 million. A dollar invested in the S&P 500 stock index for the same period would now be worth less than $4 including reinvested dividends. 

Some see the bitcoin market as “one of the greatest shorting opportunities ever,” said Lou Kerner, a partner at Flight VC who invests in the cryptocurrency. “You have a lot of zealotry, and a lot of people, including me, who think it’s the greatest thing to ever happen in the history of mankind. You have a lot of people who think it’s a bubble and a Ponzi scheme. It turns out both of them can’t be right.”

For more: Bitcoin heads to Wall Street whether regulators are ready or not

Bitcoin has been especially volatile recently, plunging nearly 20 percent in less than 90 minutes on Nov. 29, to $9,009 after briefly topping $11,000. The price has since recovered, and was trading at more than $11,332.01 at 11:42 a.m. in New York on Monday, a 3.9 percent jump since Friday.

Cboe said Monday it will start trading bitcoin futures on Dec. 10, while CME’s contracts are set to debut on Dec. 18. Nasdaq is planning to offer futures in 2018, according to a person familiar with the matter. Cantor Fitzgerald LP’s Cantor Exchange is creating a bitcoin derivative, and startup LedgerX already offers options.

Ari Paul, co-founder of hedge fund BlockTower Capital and former portfolio manager at the University of Chicago endowment, said people are mistaken if they think the famously volatile cryptocurrency is a clear-cut short.

“While some traders are eager to be able to short bitcoin and will do so when the futures are launched, there is a far greater amount of money eagerly awaiting the futures as a vehicle to go long,” Paul said.

‘Small Potatoes’

There are limited ways to short bitcoin today, said Michael Moro, chief executive officer of Genesis Global Trading. The cryptocurrency trading platform has lent about $20 million to investors to take bearish positions, which were mostly to hedge existing bets, he said. Companies like GDAX, BitMEX and Bitfinex allow investors to buy assets on margin for short periods.

“With the existing exchanges, no one can get in and short $1 million,” Moro said. “It’s really small potatoes on what you can do today. The CME guys open up a new frontier.”

Bitcoin’s 90 percent surge this year has drawn a range of reactions from Wall Street. JPMorgan Chase & Co. CEO Jamie Dimon famously called the cryptocurrency “a fraud,” while bulls including Thomas Lee at Fundstrat Global Advisors and hedge fund manager Michael Novogratz have predicted more rises.

For more: Novogratz says crypto will be biggest bubble of lifetime

The ability to short the currency is “an important part of the ecosystem,” said Novogratz, who recently began to raise $500 million to invest in cryptocurrencies. Novogratz, a bitcoin believer in the long term, has said short trades can be risky.

“There is a lot of froth,” he said at a cryptocurrency conference last week in New York. “This is going to be the biggest bubble of our lifetimes.”

Short sellers essentially borrow a security, betting that the price will fall and they can pocket the difference when they return the holding. The strategy carries risks. Borrowing bitcoin can be difficult, and price swings sudden, said Moro of Genesis.

“The concept is that this is such a volatile market that it’s going to scare a lot of investors away,” said Kerner of Flight VC.

Investors could get stung like those who bet against the internet bubble in the late 1990s, said Aaron Brown, a former managing director at AQR Capital Management who invests in the cryptocurrency.

“People who shorted the internet in 1998 were right, but they went broke before they could collect any winnings,” Brown said. “One of the problems with it, if you believe it’s a bubble or a Ponzi scheme or whatever, it can go on for a long time.”

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