Illustration by II
(Bloomberg photos)
In March 2018, Daniel Masters gave a talk at the Royal Yacht Hotel and Spa in Jersey, a U.K. tax shelter off the coast of France, attended by some of the island’s oldest families and financial nobility. The event, closed-door and invitation-only, offered a chance for some of the island’s wealthiest investors to discuss bitcoin and opportunities in the crypto space. The well-coiffed audience, sitting in plush, high-backed chairs, sipped wine and ice water while proceeding to assault Masters with a list of increasingly aggressive questions.
The greatest pushback came from the loudest — and richest — in the room.
“I was literally on my feet for two hours getting grilled,” says Masters, chairman of CoinShares, a digital asset investment firm, and former global head of energy trading for JPMorgan. “It turned into a fairly hostile reception, because here are people who have spent their entire lives accumulating wealth in fiat currency, and now you are telling them to buy another one. They don’t take very well to that.”
At the close of his presentation, a small group of people from one of the island’s offshore financial firms approached Masters. “They told me, ‘We get it, and when we take over in a few years, we’re going to be investing in this,’” he claims they said. “Many of these people, especially the ones who grew up during the Great Recession, are naturally skeptical of the banks. Many of them would actually rather own a bitcoin than a dollar.”
Masters introduced one of the world’s first regulated bitcoin hedge funds in 2014. Since then he has witnessed nearly every kind of withering cryptocurrency criticism, from banks, investors, and regulators alike. Days after Masters launched his bitcoin hedge fund, global banking giant HSBC — awash in a string of money-laundering scandals — sent his firm a letter stating that the bank would be ending their 15-year relationship and closing its accounts in 60 days. Masters found another bank and says his hedge fund went on to return more than 800 percent.
And this year, HSBC announced it will be relying on record-keeping technology that underpins bitcoin, called blockchain, to back a digital vault of about $20 billion of assets. Masters expects more crypto converts over the next decade. But he acknowledges that the era of investor incredulity and regulatory foot-dragging is far from over. “Crypto and regulation are strange bedfellows,” he says. “To get anything regulated in crypto, you have to push a very heavy ball up a very tall hill.”
Warren Buffett has called bitcoin “rat poison.” JPMorgan Chase CEO Jamie Dimon declared it a “fraud.” U.S. government agencies, watchdogs, and financial regulators chafe at the notion of institutionalizing bitcoin, citing its history of money laundering, hacks, market manipulation, and criminal activity, not to mention its mysterious creator. (In fact, bitcoin’s creator has voiced concerns about his anonymity, writing in a private correspondence with one of the cryptocurrency’s lead developers on April 26, 2011: “I wish you wouldn’t keep talking about me as a mysterious and shadowy figure. The press just turns it into a pirate currency angle.”) Yet bitcoin not only refuses to die, it has rapidly gained traction, capturing the imaginations of scientists, traders, engineers, bankers, and futurists who are assiduously introducing new innovations.
This exuberance, however, belies entrenched doubts about the cryptocurrency on Wall Street and in Washington, where high-ranking officials have made it abundantly clear — both publicly and in private — that they do not see a clear regulatory path for the institutionalization of what is arguably the world’s most audacious financial experiment since the dawn of the internet.
Jay Clayton, chairman of the U.S. Securities and Exchange Commission, has gone so far as to describe cryptocurrencies as instruments seeking to threaten the dollar’s hegemony. “Cryptocurrencies. These are replacements for sovereign currencies — replace the dollar, the yen, the euro with bitcoin,” he noted in 2018.
Since taking the helm of the SEC in 2017, Clayton has bristled at the suggestion that the agency should clarify or adjust its regulatory framework to accommodate bitcoin or any other crypto-related products. In his defense, Clayton cites the SEC’s history of building “a securities market that’s the envy of the world, following these rules.” Although some believe that SEC regulations spanning nearly a century may be in need of some updating, Clayton has shown no sign of changing his position, stating late last year, “I think a lot of people got excited that somehow we would change the rules to accommodate the technology and they invested their time and effort thinking that would happen. I have been pretty clear from the start: That ain’t happening.”
But just ahead of this summer, with markets in turmoil amid the spread of the coronavirus, bitcoin received an unexpected anointing from one of the world’s top hedge fund managers. On May 7 billionaire Paul Tudor Jones of New York–based Tudor Investment Corp. issued a market outlook letter that swiftly went viral across Wall Street.
In it he parses the global ramifications of flat-footed policy responses to the pandemic, the effects of worldwide quarantines and lockdowns, and the magnitude of the economic downturn, which has led to an avalanche of fiscal spending on a scale that, he suggests, is objectively alarming.
“It has happened globally, with such speed that even a market veteran like myself was left speechless,” he writes in the letter. “We are witnessing the Great Monetary Inflation, an unprecedented expansion of every form of money unlike anything the developed world has ever seen.”
Assessing a range of investments that might provide the best refuge from this economic storm, Jones does not mince words: “The question facing every investor is, ‘What will be the winner in ten years’ time?’ At the end of the day, the best profit-maximizing strategy is to own the fastest horse. Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be bitcoin.”
Before Jones’s letter, there was little upside for Wall Street’s cognoscenti in advocating for bitcoin, lest they be accused of touting “pirate currency.” After Jones’s letter, the shift, however, has been palpable.
“Everyone’s standing on the edge of the pool saying, ‘The water looks nice, but I am not sure I want to jump in,’” says Masters. “And Paul just jumped in. With a single letter to his investors, he removed the perceived career risk that an institutional investor might fear by investing in bitcoin.”
At the time, Jones says in his May letter, he began trading a small amount of bitcoin in his personal account “for fun.” Between January 2017 and December of that year, bitcoin rose from the low $900s to just under $20,000. “I doubled my money and got out near the top when it was apparent to any market technician we were blowing off,” Jones writes. “It is amazing how well one can trade when there is no leverage, no performance pressure, and no greed to intrude upon rational reflection. When it doesn’t count, we are all geniuses.”
Within a year of its high, bitcoin dropped to the $3,000s, and is now trading in the $9,000s. But Jones is no longer looking at bitcoin as a token curiosity. Against the backdrop of the catastrophic economic landscape, he is looking at it as an investable asset, not just for himself, but for his $9 billion fund, Tudor BVI.
“Truth in advertising,” he says in the letter. “I am not a hard-money nor a crypto nut. I am not a millennial investing in cryptocurrency, which is very popular in that generation, but a baby boomer who wants to capture the opportunity set while protecting my capital in ever-changing environments. One way to do that is to make sure I am invested in the instruments that respond first to the massive increases in global money. And given that bitcoin has positive returns over the most recent time frames, a deeper dive into it was warranted.”
Says one person close to the fund, “Paul did not go into this looking to justify an investment in bitcoin. To be honest, he was startled by the results of the fund’s analysis. He went into it looking for the market’s best inflation hedges.”
The fund’s analysis is worth examining. Bearing in mind that the U.S. Federal Reserve’s balance sheet is on track to more than double by the close of 2020, Jones decided to poll the fund’s research group to grade key investable assets by their ability to store value, scoring them from zero to 100. Financial assets ranked highest, at 71 — to be sure, a very generalized category; gold at 62; fiat cash at 54; and bitcoin at 43.
The group also created subcategories, such as trustworthiness, liquidity, portability, and purchasing power. Of the latter, Jones writes: “The most surprising result of our research group poll was the score ascribed to fiat cash. It got a zero almost across the board! The cry from the troops was, ‘If something is by design going to depreciate 2 percent per year through inflation — why own it?’” On trustworthiness, 11-year-old bitcoin struggled the most compared with gold, which has a track record spanning 2,500 years. On liquidity, portability, and purchasing power, though, bitcoin did very well. “Interestingly, bitcoin is the only store of value that actually trades 24/7 in the world,” Jones notes of the liquidity. On portability, he says that gold is “ok, but clunky,” but “nothing beats bitcoin, which can be stored on a smartphone.” On purchasing power, Jones writes that he again favors bitcoin, as it is the only large tradable asset in the world with a known fixed maximum supply. Because bitcoin is algorithmically designed not to exceed 21 million bitcoins total, with 18.5 million coins already it embodies “the quintessence of the scarcity premium,” Jones explains, making bitcoin “increasingly near and dear, a concept alien to the current thinking of central banks and governments.”
Jones also believes bitcoin is cheap. “Bitcoin had an overall score of nearly 60 percent of that of financial assets, but has a market cap that is 1/1,200th of that,” he notes in the letter, citing his fund’s analysis. “It scores 66 percent of gold as a store of value but has a market cap that is 1/60th of gold’s outstanding value. Something appears wrong here, and my guess is it is the price of bitcoin.”
Jones says he plans to focus on trading bitcoin futures and will keep the fund’s investments in the low-single-digit range as a percentage of overall assets. In March the hedge fund of Jim Simons, founder of Renaissance Technologies, also announced it had received approval from the SEC to trade cash-settled bitcoin futures contracts on the Chicago Mercantile Exchange for its $10 billion Medallion Funds. “The underlying commodity for these futures transactions, bitcoin, is a relatively new and highly speculative asset,” Renaissance Technologies said in a statement, noting that bitcoin and futures based on bitcoin are extremely volatile and “involve substantially more risk and potential for loss relative to more conventional financial instruments.”
Jones similarly sounds a word of warning near the end of his recent letter. “I am not an advocate of bitcoin ownership in isolation, but I do recognize its potential in a period when we have the most unorthodox economic policies in modern history.”
Even Simons’ fund issued a 12-point list this past spring ticking off the risks associated with investing in bitcoin — among them “its susceptibility to manipulation by malicious actors or botnets, . . . the susceptibility of bitcoin spot exchanges to the risk of fraud, manipulation, and other malfeasance, [and] the absence of any recognition of bitcoin as legal tender by any government.”
Bitcoin and many cryptocurrencies like it are virtual representations of money consisting of nothing more than computer code. Like conventional currencies, they can be traded online, transferred, stored, or exchanged for cash. But unlike conventional currencies, they live primarily on the internet, secured by layers of computer code, and can be sent across international borders as easily as sending a text.
This works well for those who want a secure way to send or receive money by laptop, mobile phone, or email, without the need for an intermediary or a traditional bank account. Unfortunately, it also works very well for criminals and terrorists — often the first adopters of new technologies — who the U.S. government fears might try to develop their own virtual currencies that will be far more potent and harder to track than bitcoin.
Joe Eagan, president of San Francisco–based Polychain Capital, which became the first $1 billion crypto fund in 2018 and makes venture capital investments in crypto businesses, says many investors do not realize the many applications of bitcoin and blockchain, considering cryptocurrencies merely places to park capital. “There’s a misperception that it’s a disrupter as a store of value, or an interesting hedge, because it’s a deflationary asset,” he says. “Cryptocurrencies are actually programmable technology that has all the benefits of decentralization but can be used to build completely new technologies. We have a flexible technology for massive disruption.”
But privately, a number of hedge fund traders confide that they harbor worries that bitcoin could eventually be banned by the U.S. government. (Trading bans have happened before, such as with futures on onions, Maine potatoes, and motion picture box office receipts.) Back in 2015, JPMorgan’s Dimon said as much, auguring, “There will be no real, non-controlled currency in the world. There is no government that’s going to put up with it for long.”
Although the more melodramatic statements have not aged well, dire predictions that bitcoin will upend American fiat or sovereignty have circulated since its launch — and they are not all wrong.
“There is no question this is an arena that could create risk, and we need to understand what those risks are,” says Juan Zarate, global co–managing partner and chief strategy officer for K2 Intelligence Financial Integrity Network, a Washington, D.C., advisory firm for compliance, risk management, and investigations into financial transparency and security. “The fact that bitcoin and other cryptocurrencies are technologies that can be used in many different ways has made it hard for U.S. regulators and policymakers to decide, ‘What are these things, and how should they be treated?’”
Zarate, a longtime adviser to San Francisco digital currency exchange Coinbase, once led the elite team at the U.S. Department of Treasury targeting, blocking, and freezing the financial assets of America’s enemies — including Iranian money launderers and associates of Russian President Vladimir Putin.
It has long been known that America’s ability to financially disable, dismantle, and destroy nefarious networks is vital to U.S. national security. Financial coercion is frequently safer and more effective than deploying troops or engaging in diplomacy. The U.S. is currently keeping a close watch over how China, Iran, Russia, and Venezuela develop cryptocurrencies and blockchain technologies, as creating alternative payment systems for global commerce could allow them to bypass U.S. economic sanctions, according to the Foundation for Defense of Democracies, a Washington, D.C., national security and foreign policy research institute. Zarate serves as chairman and co-founder of the foundation’s Center on Economic and Financial Power.
“Blockchain technology may be the innovation that enables U.S. adversaries for the first time to operate entire economies outside the U.S.-led financial system,” the foundation warned in a report released last July, adding that the process could take “two to three decades, but these actors are developing the building blocks now; they envision a world in which cryptocurrency technology helps them eclipse U.S. financial power, much the same way that the dollar once eclipsed the British pound.”
The U.S. needs to act decisively to integrate “digital currency technology with the law-based financial order” if it is to safeguard “the integrity of global finance and cultivate the expertise and influence to lead in what is becoming an international crypto race,” the foundation says. And though the U.S. government is openly monitoring certain parts of the cryptoverse, it has surveilled other parts more clandestinely.
In the lead-up to bitcoin’s record highs of 2017, Computer Sciences Corp. — a digital information technology company whose sister firm, CSRA, runs the IT backbone of the U.S. National Security Agency — quietly hired hundreds of specialists across the financial and health care sectors to explore how blockchain technology could drive faster banking, trading, clearing, and settlements.
Computer Sciences, renamed DXC Technology following a merger in 2017, believes the U.S. may fully transition to cryptocurrency by 2040, calling bitcoin a revolutionary innovation, “breathtaking in its ambition,” and striking for its “attempt to overthrow a sovereign authority.”
CSRA, which also works closely with the U.S. Department of Homeland Security, has watched the progress of bitcoin since its earliest days, but has declined to provide details.
Notes Zarate, “The introduction of bitcoin has brought with it a whole new set of vulnerabilities and risks that have not been fully accounted for. Law enforcement is leveraging tools from the technology sector much more aggressively and effectively, but we are still learning. That being said, we are in a much more mature state than just a few years ago, with the crypto universe starting to look and feel more like a part of the global financial system.”
Divisions among market regulators have emerged over how heavily to gate-keep crypto’s expansion — and whether waiting too long could, in fact, put America’s financial primacy at risk.
The current Congress has introduced more than 30 bills focused on crypto — the most ever — with the largest proportion centered on how to regulate bitcoin, other cryptocurrencies, and blockchain technology. The second-biggest focus is on cryptoterrorism, money laundering, and human and sex trafficking.
And though SEC chairman Clayton has all but declared war on crypto, another SEC commissioner, Hester Peirce, has become one of the most prominent crypto advocates in Washington. Since joining the SEC in 2018, she has argued for greater access for both institutional and retail investors to bitcoin and other crypto products, earning the moniker “crypto-mom” for repeatedly defending market innovations following agency decisions that blocked access to bitcoin products on the nation’s securities exchanges.
In a dissenting opinion she wrote in February, Peirce highlights what she calls a “long string of disapproval orders” the SEC has issued on proposals from NYSE Arca, the Winklevoss twins, and others to bring bitcoin products to market. “This line of disapprovals leads me to conclude that this commission is unwilling to approve the listing of any product that would provide access to the market for bitcoin and that no filing will meet the ever-shifting standards that this commission insists on applying to bitcoin-related products — and only bitcoin-related products,” she says.
Peirce says she believes bitcoin’s checkered past is very likely part of the problem. “I have my suspicions that people look at bitcoin and [other] cryptocurrency through the lens of their notorious early uses, and I think that shadow has hung over bitcoin for a long time,” she explains in an interview with Institutional Investor. This is ironic, she says, as “it’s easier to track bitcoin than most dollar transactions.”
One of the most heated battles over the institutionalization of bitcoin has been a years-long push to get an exchange-traded bitcoin fund approved for U.S. markets — an effort that, so far, has failed nearly a dozen times.
For its part, the SEC has cited fears of market manipulation and insufficient bitcoin market surveillance, and has maintained that the markets for bitcoin have not grown to a large enough size yet to introduce an exchange-traded fund. Peirce questions this, stating, “More institutional participation would ameliorate many of the commission’s concerns with the bitcoin market that underlie its disapproval orders.”
She strongly dissented in 2018 when the SEC shot down a proposed rule change that would have paved the way for the Winklevoss Bitcoin Trust to be listed on the Bats BZX Exchange. “I am discouraged by the current approach,” Peirce tells II. “I think it is a misguided approach to investor protection.” She found that the commission seemed less focused on its regulatory mandate and more interested in ruling on the merits of the underlying bitcoin spot and futures markets.
“Our assessment shouldn’t be based on the merits of the product,” Peirce says. “I don’t want to be in the role of deciding whether it’s a good or bad product to trade. Our job is to make sure investors are safe and the rules are being followed, that investors have an opportunity to decide if they want to trade something or not.”
Tyler and Cameron Winklevoss say they grasp the SEC’s reasons for not approving exchange-traded bitcoin products. “We definitely believe in the ETF product, but we also understand the commission’s concerns and the need to get it right,” Cameron says. The twins are co-founders of Gemini, a regulated cryptocurrency exchange and custodian in New York; Cameron is president and Tyler is CEO. They are also both principals of Winklevoss Capital, their family office in New York.
Although the Winklevosses have no plans at this time to file again with the SEC, a positive development came this spring when JPMorgan — which, until recently, had long resisted crypto — took on Gemini and Coinbase as its first banking clients in the cryptocurrency industry. The move came a year after JPMorgan became the first American bank to introduce its own digital currency — JPM Coin.
In June a New York asset manager, WisdomTree Investments, floated plans to launch an exchange-traded commodities fund that would include up to 5 percent exposure to cash-settled bitcoin futures on the Chicago Mercantile Exchange. Some market participants regard this as a litmus test to see if the SEC will also reject this filing, despite the fact that bitcoin would represent only a very small portion of the fund.
Tyler Winklevoss says one of the major impediments for regulators seems to be that exchanges trading bitcoin span a wide range of markets and jurisdictions, a number of which are not well regulated. “Many of the concerns seem to focus on marketplace and market structures, many of which are not in the U.S.,” he explains. “They would like to see a liquid derivatives market in bitcoin where the price is being set more on regulated derivatives exchanges in the U.S.”
From Peirce’s perspective, that is less likely to happen if the SEC continues to throw up roadblocks that prevent the greater institutionalization of the bitcoin market. “I would want to set up the regulatory infrastructure in such a way that we don’t make it so hard for people to introduce new products that they would end up offering it somewhere else,” she says. “I want to set up a framework where we can say, ‘You can try that here.’”
Says one person who works closely with the SEC, “Clayton’s reservations are myriad. His feeling is, ‘I don’t want my legacy to be the guy who opens the floodgates that lead to an event, like volatility or a hack.’ He doesn’t want to be there when consumers are calling the SEC asking, ‘How do I get my keys back on my bitcoin?’”
But with Clayton’s recent nomination to become the next U.S. attorney for the Southern District of New York, Peirce may have the chance to lead the commission, just as she embarks on her second term at the agency. “We are in a place now where the target is moving,” she notes, adding, “I remain optimistic that there will be forward movement.”
