Why The ‘Big Short’ Guys Think Bitcoin Is A Bubble

During the past year of COVID-induced market mania, cryptocurrencies have gone up so much — bitcoin is up about fivefold, while many other crypto projects are up far, far more — that even reluctant Wall Street institutions have begun to tiptoe into the arena.

A blazing rally that began this month has helped bitcoin shoot up nearly 50 percent in two weeks. It was driven by various pieces of news — for instance, George Soros’s family office disclosed that it holds some — but the biggest force was the increasingly certain expectation that the federal government will approve the first bitcoin-based exchange-traded fund, which will allow retail investors to buy in more easily, including for 401(k) accounts. (The ETF could begin trading as early as Monday.)

But doubters remain — and their ranks just happen to include many of the same prominent investors who saw the financial crisis of 2008 coming.

Hedge-fund mogul John Paulson, who was behind the “the greatest trade ever” — in 2007, he personally made $4 billion on his short of subprime mortgages — thinks cryptocurrencies are a bubble that will prove to be “worthless.”

Michael Burry, the quirky hedge-fund manager made famous in The Big Short movie (played by Christian Bale), complains that no one is paying attention to crypto’s leverage. For months, he has been suggesting that bitcoin is on the precipice of collapse.

And NYU professor Nassim Taleb, whose now-canonical book The Black Swan warned about the dangers of unpredictable events just ahead of the subprime crash, argues that bitcoin is functionally a Ponzi scheme.

Other famous critics include economist Nouriel Roubini, one of the few in his profession to predict the financial crisis, and hedge-fund billionaire and hard-money acolyte Paul Singer, whose speech at a prestigious investment conference in 2006 described the eventual “wipeout” of mortgage securities.

Singer, the founder of the $48 billion investment firm Elliott Management, thinks cryptocurrencies are a fraud, but is apparently tired of complaining about them.

“Pulling out your hair is an option, though only if you have hair to spare,” the balding 77-year-old Singer wrote in his first-quarter letter to investors this year. “We continue to press on for the day when we can say, ‘We told you so.’”

Since then, though, the bitcoin bulls have only grown more optimistic. Despite a steep sell-off in May and the growing certainty that the Securities and Exchange Commission, the U.S. Treasury, and even the Department of Justice are getting ready to clamp down on the cryptocurrency world, retail and institutional investors alike have kept buying.

When China announced on September 24 that it would ban all cryptocurrency activities, bitcoin fell less than 6 percent.The total value of all cryptocurrencies is now estimated at $2.5 trillion, and a single bitcoin trades for around $60,000 (up from a low of around $4,000 during the broader market crash in March of last year).

Cryptocurrency investors have also been largely unfazed by the fact that, in the case of bitcoin, the term “currency” is something of a misnomer. “Nothing is priced in bitcoin,” Roubini noted in a recent Goldman Sachs research report. While Starbucks might offer customers the option of buying their coffee with bitcoin, no one actually chooses to do so.

But one of the crypto world’s most powerful and influential investors has a theory on why 2008 Cassandras — Burry in particular — only see gloom and doom ahead for bitcoin. Zhu Su, founder of Singapore-based Three Arrows Capital, tweeted earlier this month:

“The desire to be consistent with oneself is the source of poor decision-making. The winners of the Big Short came to define themselves as bears and proceeded to underperform everyone for 13 years. There’s never a need to define yourself. The market does not care who you are.”

He tagged Burry in the thread. A few days later, he opined: “22yo old Burry would be max long Bitcoin imho. Age changes a man, and if he’s not careful, cringes him.” (In other words, these are just old guys who can’t help fighting the glorious last war.)

It was, in part, a response to Burry musing on Twitter about actually going short on bitcoin — that is, making a real-life financial bet that it will go down, rather than just talking about it. The fact is that most bears — including the ones quoted here — aren’t actually shorting bitcoin, even as they predict its demise.

In a Bloomberg interview, Paulson noted that unlike his lucrative “big short” trade, cryptocurrencies are too volatile and risky to make them a good short.

It’s undeniable that bitcoin pessimism has been costly (at very least in opportunity terms) over the past decade, making it easy to dismiss the naysayers for spreading “FUD” — or “fear, uncertainty, and doubt.”

But Mike Green, a prominent investment strategist who was also short subprime before the financial crisis, when he worked at hedge fund Canyon Capital, nonetheless shares the perspective of his fellow ’08 Cassandras.

“These guys tend to be good b.s. sniffers,” he says. “My view is that bitcoin will ultimately end up going to zero. And I think we are in the final stages right now.”

Green says he began looking into bitcoin because clients were clamoring to invest in it. “As I dug into the actual underpinnings, it just became very clear that what was actually going on was cultlike behavior with no real understanding of the asset or the economic implications for the model that it was proposing,” he says.

Bitcoin, of course, was born of the Great Financial Crisis and the beginnings of an erosion of trust in Wall Street and monetary authorities. The first block of the now 12-year-old blockchain encodes mention of a news story about bank bailouts.

The once-niche and -derisive term “fiat currency” — money issued by central bank fiat rather than, say, mined out of the ground as gold was — has, rather remarkably, gone mainstream as bitcoin and the worldview that inspired it have taken root in the public imagination.

“What’s the value, what’s the purpose of bitcoin? To take away the Fed?” asks one outspoken short seller, who wanted to remain anonymous, because “I don’t need the bitcoin guys after me.”

“I kind of like to have the Fed run by Ph.D.’s who went to work for the government being the people deciding fiscal policy more than a bunch of kids,” he says, referring to the generation of extremely online young people who have figured prominently among the early adopters of bitcoin. “And the U.S. dollar is backed by the full faith of the United States. Does bitcoin have an army?”

“It’s just a big scheme,” he says, “and so intellectually wrong.”

In recent days, hedge-fund billionaire Ken Griffin, CEO of Citadel, joined the chorus of critics, calling cryptocurrency a “jihadist call” against the dollar.

“What a crazy concept this is that we as a country embrace so many bright, young, talented people to come up with a replacement for our reserve currency,” he said at the Economic Club of Chicago.

Bitcoin, its critics like to say, is nothing but electricity. “To tell me that something that’s constructed as a computer program, where you engage in some process of sitting there in front of your computer and, after a period of time and the expenditure of a bunch of electricity, a message appears on your screen that you have created something, that’s ridiculous,” Singer said on an investment podcast earlier this year. “It’s nothing.”

As Roubini put it in the Goldman report, “Bitcoin and other cryptocurrencies have no income or utility, so there’s just no way to arrive at a fundamental value.” He also scoffs at those who call it digital gold. “Bitcoin could disappear one day, but gold won’t.”

Bitcoin’s advocates tout it as an inflation hedge — but the jury remains out on that question. In practice, it has been heavily correlated to the stock market, if a lot more volatile (going up more on good days and down more on bad ones).

While bitcoin has lately showed some ability to move independently of the S&P 500, posting gains even when  the market declined, critics still see it behaving more like a meme stock than an established asset class.

“Crypto people think it’s an antidote to central-bank bubbles, but it has actually become a symptom,” says Mark Spitznagel, founder of Universa Investments, a hedge fund that made headlines by producing eye-popping gains during the COVID crash last year.

Spitznagel, also a fervent critic of the Fed’s monetary policies post-crash, says cryptocurrencies themselves are fiat currencies, because they are “created out of thin air.”

“People buy it thinking that the next guy will come along and subjectively value it higher,” he says. “That looks like a Ponzi scheme.”

The core element of any pro-bitcoin argument is decentralization and transparency, but Roubini has asserted that an “oligopoly of miners” control bitcoin, pointing to the prevalence of countries like China and, to a much lesser extent, Russia and Iran, in crypto-mining.

The strength of this argument may be waning though. Until recently, China accounted for more than 50 percent of all mining, but it’s unclear how much — if any — of that capacity remains online now that the central government has banned the industry. In practice, much of it seems to be moving to the United States, particularly Texas.

The question of illicit transactions and money-laundering does still hang heavy over bitcoin, referenced often by financial authorities as a cause for concern. Green estimates that 40 percent of bitcoin’s real-world transactions are still criminal in nature (don’t forget, the first killer app was black-market bazaar Silk Road), including recent ransomware hackings.

Bulls argue that the real number is a lot lower. A report by industry firm Chainalysis pegged it at less than one percent in 2020 — less than than comparable figures for cash.

Similar questions and uncertainty swirl around the decision by El Salvador to adopt bitcoin as legal tender. “I would broadly describe what’s going on with El Salvador as they’re trying to make money-laundering the national business,” says Green, who contends that El Salvador is at risk of becoming a narco state.

Bitcoin bears say crypto’s transparency is also overstated. To be sure, every transaction is recorded on the blockchain, a digital ledger that has been highly touted for potential broader use. But that doesn’t mean the market is transparent. If cryptocurrency were truly transparent, it might be possible to know how much leverage is currently in use in crypto markets. 

The Economist recently calculated that “90 percent of the money invested in bitcoin is spent on derivatives like ‘perpetual’ swaps — bets on future price fluctuations that never expire. Most of these are traded on unregulated exchanges … from which customers borrow to make bets even bigger.”

No one knows what the actual leverage is, says Green, who adds that some of the trading is simply fake buy-and-sell orders, known as “wash sales,” that give the illusion of activity.

The leverage could kill it, Michael Burry argued in a series of tweets that have since been deleted. “If you don’t know how much leverage is in crypto, you don’t know anything about crypto, no matter how much else you think you know,” he tweeted in June, saying its collapse will trigger “the mother of all crashes.” He likens it to the dot-com bubble of 1999 and the housing one of 2007.

Crypto mania is “the perfect love child” of those two predecessors, says Josh Wolfe, who lived through both eras on Wall Street and is the co-founder of venture-capital firm Lux Capital. The cryptocurrency world contains both the technological innovation of the dot-com boom and bust and the leverage associated with the housing bubble’s complex securitization, as well as its evasion of regulation. (As much as he abhors cryptocurrency promoters and pumpers — of which there are many — Wolfe argues the innovative blockchain infrastructure will survive.)

One of the longest-running bearish narratives around bitcoin concerns Tether, the Hong Kong–based stablecoin — the idea is that one Tether is always worth a dollar — with more than $68 billion of tokens now in circulation. Stablecoins are supposed to be backed by riskless assets, as they act to grease the wheels of crypto-trading exchanges around the globe.

But regulators and investors alike have long worried about the quality of Tether’s collateral, and whether the project might not be prone to collapse. (Bloomberg reported recently that some of Tether’s reserves might be held in Chinese commercial paper — a particularly dicey asset class at the moment, following the implosion of real-estate giant Evergrande.)

The U.S. government is now trying to figure out how best to regulate stablecoins and their potential impact on the broader financial system. Gensler, for example, has called them “poker chips” and says they should be considered securities that the SEC could oversee.

If left unregulated, he said at a recent conference, cryptocurrency markets “will not end well.” The Treasury Department is also considering regulating Tether — which is under criminal investigation by the Department of Justice — like a bank, as it has been used to avoid both money-laundering rules and taxes.

Lack of regulation, however, is the point of the free-market world of cryptocurrency, says Green. He notes that the venture capitalists who’ve dreamed up many of the new tokens and exchanges come from a culture that created popular new businesses, like Airbnb and Uber, which thrive by avoiding the type of costly regulations that govern their established rivals. The VC world calls it disruption; Green calls it regulatory arbitrage.

The crypto world is clearly nervous about more regulation. “What could go wrong with crypto? Well, what could go wrong is we could have some really crappy regulation, which will slow things,” Michael Novogratz, hedge-fund manager turned bitcoin pioneer who founded financial firm Galaxy Digital, told attendees at bitcoin promoter Anthony Scaramucci’s SALT conference in New York in September.

At the same conference, hedge-fund mogul Ray Dalio of Bridgewater Associates, who dabbles in cryptocurrencies, said he believed regulators would “kill” bitcoin if it became too successful.

Spitznagel agrees with that assessment. “I can see why governments need to fight this thing. They are probably going to shut it down at some point.” (Here, a more neutral observer might point out that bitcoin is a decentralized global network, and that one national government — or even many governments together — can’t just “shut it down.” As long as there are computers somewhere in the world running the program, bitcoin is technically alive and functioning.)

Even expectations of a China-like bitcoin ban in the United States might not be reality-based. The federal government treats bitcoin as property, and Gensler’s regulatory hawkishness has generally included exceptions for bitcoin itself.

His agency is the regulatory authority that seems ready to let a bitcoin-futures ETF begin trading on a U.S. exchange next week. Federal Reserve chairman Jerome Powell said recently before Congress that he did not intend to ban it.

Meanwhile, flush with cash, the new crypto industry is busy lobbying Congress to thwart any new regulations, including efforts to tax crypto, and has drawn mostly Republicans to its side.

Beyond all the specific arguments and counterarguments, the fact remains that those from the “big short” set making the case against bitcoin are generally not making the same kind of real-life short bets that made them so much money in 2008. Whether that is the real tell here or just an oddity of this particular bubble remains to be seen.

“You can’t be short it in scale,” agrees the short seller. Like some of the others who fundamentally dislike it, he even has a small position in bitcoin. “If it goes up, I’ll make a little bit of money. If it goes to zero, I’ll be so happy, I will gladly lose the money.”

Michelle Celarier for the NY Mag where this article was originally published.