Forget gambling in Bitcoins. But, they can give you the best
arbitrage opportunities!
Many of my colleagues ask me, “When are you investing in
Bitcoins?” I always reply, “Neither me, nor you, nor anybody else can ever
invest in Bitcoins. You can only gamble with them!” That’s how I exactly define
the difference between investing and gambling. I recall an interview of Jack Ma
– Founder & Executive Chairman, Alibaba Group, who admitted openly that he
doesn’t understand the price changes of Bitcoins and hence stays away from
putting his money into the cryptocurrency. Indian ace investor – Rakesh Jhunjhunwala
admitted publicly that he doesn’t understand the business model of many of the
businesses present in the e-commerce space; he stays away from investing in
businesses that he doesn’t understand, as it would be gambling in that
business.
When you don’t understand
something, stay away from putting your hard-earned money in it.
Fair enough!
That’s the only reason I stay away from investing in
Bitcoins. I understand them being a vehicle for transaction, but I am never
sure how their price may move the next minute. This goes in similar lines when
Bitcoin recently lost 20% of its all-time high value in just 1 hour, and is now
trading at below USD 8,000 just a few weeks from its all-time high of USD
19,343.
Confused, I went through a few videos on what determines
Bitcoin prices as I believe that when people are ready to put in so huge amount
from their hard-earned money in such a volatile instrument, there should be some
underlying valuation technique. I came across an interesting video by Tom Lee
of Fundstrat Global Advisors, who explained valuation of Bitcoin using Metcalfe’s Law which states,
“The value of a network
is proportional to the square of the number of connected users of the system.”
So, the cryptocurrency can be valued as the square function
of the number of users times the average transaction value. This is what can be
said to be the Network Effect. When I went through the bitcoin price as compared
to the valuation technique proposed by Tom Lee, I came across the following graph,
That was pretty close!
All these in place and given the valuation technique, I was
still reluctant to trade Bitcoins given its volatility and no asset backing. I
invest in equities, but all of them have an asset backing. Being a participant
in financial markets, I have learnt one thing that you need to follow a
discipline while investing; you need to keep greed aside. Follow fundamentals and take cue from technicals and market psychology while
making an investment decision.
While I strongly believe that when investing, your instrument
need to be asset-backed or be a representative of an asset, the second thoughts
were – Am I missing on technological advancement? Am I being an orthodox
investor who doesn’t want to evolve? Has the definition of investing changed in
this exponentially evolving technological world? But then I heard Jamie Dimon –
CEO, JPMorgan literally boycotting Bitcoins and strongly discouraging any of
the company’s employees from trading in the cryptocurrency. I was relieved that
I wasn’t the only one thinking so. But then I thought of the second-order
implication: Will JPMorgan be the next Nokia or Kodak with this thinking?
We are in a financial world, where participants break or make
overnight. Who imagined Lehman Brothers would go bankrupt with just flick of
fingers? And Bear Stearns? Participants in financial markets need to keep
updated and use the advancement in technology for added benefits while keeping
aside emotions or greed while taking a position in the market.
While I am still juggling and have not been able to convince
myself to ‘invest’ in the volatile Bitcoins, I have found another strategy to
use the cryptocurrency to make money. I am hitting upon something that uses the
present currency market and Bitcoin market to take an advantage of Arbitrage opportunity
that a mixed strategy can give, making use of both the markets.
Let’s take a simple case of that I came across today,
Date: February 09, 2018
Time: 03.01 am
Source: Marketwatch
Bitcoin was trading @USD 8005.97 at 03.01 am and @EUR 6527.29
at the same time.
At 03.01 am, the currency market was showing the following
quotation,
Source: Reuters.in
Note: USD/EUR rate (read as 1 USD = xy.abcd EUR)
At this quotation,
For converting USD to EUR,
Bid Price = 0.8155
Ask Price = 0.8157
At the same time, while converting EUR to USD, the bid and
ask price interchange i.e.,
Bid Price = 1/0.8157 = 1.2259
Ask Price = 1/0.8155 = 1.2262
At this quotation for Bitcoins and exchange rates as of 03.01
am, one can take the following strategy to take an advantage of an arbitrage
opportunity with Bitcoins,
- Convert USD 8004.0343 to EUR 6527.29 @0.8155 bid rate
- Buy 1 Bitcoin @EUR 6527.29
- Sell 1 Bitcoin @8005.97
In this whole transaction, the trader doesn’t risk the
implications of wild volatility in prices that trading in Bitcoin would result
in, at the same time making money from arbitrage!
I believe that arbitrage is a far better strategy while trading
with Bitcoins, rather than going long on this extremely volatile vehicle. I am personally
a risk-averse investor and would stay away from such a risky trade. For
investors and traders having a huge risk appetite can definitely consider this
opportunity!
- Harsh Pathak
President - Finance Club, MISB Bocconi
Contact: +91 98209 76480
Email: harsh.pathak@misbbocconi.com; harsh.pathak0509@gmail.com
LinkedIn: https://www.linkedin.com/in/harsh-pathak-2a960559/
