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Digital Derivatives WeeklyMay 16, 2020

Digital Derivatives - Why Paul Tudor is Long Bitcoin

Jitender Tokas
Chief Business Officer
May 16, 2020
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    Market Moves

    Derivatives Insights

    Billion Dollar Hedge Fund is Long BTC

    If you haven’t heard by now, Paul Tudor Jones – who manages the ~$8bn hedge fund Tudor Investment Corporation – is long bitcoin.

    Last week, Mr. Tudor revealed that his fund has allocated ~1-2% of the fund’s capital to a long Bitcoin futures position.

    It is a safe assumption that this position has been taken in the Bitcoin Futures trading on CME, and the trading activity of this futures contract is a good proxy for institutional investors’ interest in cryptocurrencies.

    As things stand today, CME bitcoin futures monthly trading volume is $6.78B and open interest is at a record high of $529 million. Compare this to BitMex’s BTC Perpetual contract: Monthly trading volume = $77.12B and current open interest = 57.69k BTC ($554 million). It is interesting to note that Open Interest at CME’s Bitcoin futures has come pretty close to that of BitMEx.

    Why Paul Tudor likes Bitcoin

    Pauæ Tudor sees Bitcoin as a strong inflation hedge. The ongoing ‘Great Monetary Inflation’ in which central banks around the world are printing money has significantly increased the risks of hyperinflation in the future. With growing economic uncertainty and unprecedented levels of global debt, the importance of an effective store of value has never been more evident. Tudor sees Bitcoin as this store of value.

    A store of value asset is “anything which holds its purchasing power in the long run.” It is a function of psychology, with a value based on people’s perception of the assets worth, with both tulips, fiat, gold and Bitcoin functioning as stores of value at one time.

    The effectiveness of a store of value asset can be ranked across 4 dimensions:

    • Purchasing Power – Is asset value maintained over time?
    • Trustworthiness – How is the asset universally perceived?
    • Liquidity Can it be exchanged into a transactional asset?
    • Portability – Can the asset be geographically moved?

    The Tudor team compared Bitcoin against the following assets – financial assets, cash, gold – and assigned them subjective scores. Below is their analysis:

    Purchasing Power

    One argument to address is the need for a financial yield to defeat inflation – a consistent return above the inflation rate. If the emphasis is on this, the clear (and only) winner is financial assets. However, Tudor notes the double-digit inflation rates of the 1970’s with financial assets unable to keep up.

    Another angle to address is that of scarcity. Bitcoin is the only asset analysed with clear fixed maximum supply built into its system. Roughly 10% of the total available Bitcoin are left to be mined, with roughly 18.5m circulating out of a total of 21m. With the rate of newly issued BTC slowing down gradually, Bitcoin is a truly unique asset.

    Trustworthiness

    To nobody’s (and everybody’s) surprise, Bitcoin scored the lowest here. As the youngest entrant, Bitcoin has a lot of work to do to convince investors of its trustworthiness as an asset. However, with +60m users across 200 countries, a transparent foundation and an algorithmically fixed supply rate, arguments could be made for the opposite. Gold happened to score the highest here, standing the test of time for thousands of years.

    Liquidity

    The case for Bitcoin here is its 24/7 tradable nature. It is the only observed asset which can be traded at all times. Cash otherwise scored the highest in this category – and rightfully so – with Bitcoin, financial assets and gold following suit.

    Portability

    Portability is, like liquidity, irrelevant until it isn’t. Here, the asset must be transferable across borders with minimal hassle and costs. Cash is decent, but realistically gets difficult to manage as the amount grows. This is similar to gold – difficult to transfer above a certain threshold. Bitcoin is the clear winner here, with billions of dollars worth of the asset capable of being stored on a ledger the size of a USB stick.

    What’s The Verdict?

    Asset Subjective Score
    Financial Assets 71
    Gold 62
    Fiat Cash 54
    Bitcoin 43

    Assets ranked according to Tudor

    To few people’s surprise, Bitcoin came last. It is unproven with only 10 years to its name.

    However, that wasn’t the interesting part. What is worth noting is the ultimate ranking of Bitcoin relative to its peers.

    • Bitcoin had a score of 60% of that of financial assets, with a market cap that is 1/1200th of financial assets.
    • Bitcoin had a score of 66% of that of gold, with a market cap that is 1/60th of gold.
    • Bitcoin had a score of 79% of that of cash, with a (proxy) market cap that is 0.46% of cash.

    Tudor sees Bitcoin price as an outlier. His key argument for Bitcoin here is the quantity of people who can own the asset who do not currently own it. Virtual currency wallets are becoming increasingly commonplace throughout the world and this will only grow as Facebook introduces Libra and China introduces their DCEP. This makes Bitcoin more commonplace and easy-to-use day by day.

    The key thing that is unique to Bitcoin – compared to almost all other assets on this planet – is its removal of the need for trust. Bitcoin is an open-source network built upon a transparent ledger system with a fixed supply rate. There will be no unexpected printing or debasing, no downtimes, no access restrictions. There is no need for the trust which we place in central banks and governments to maintain current currency systems.

    Bitcoin as compared to Gold

    Tudor believes that the Bitcoin ecosystem today is where Gold was in 1976. At the time, Gold had just been made into a futures instrument (as is the case with Bitcoin) and enjoyed tremendous price volatility. Gold went on to quadruple over the next 3 years – between 1977 and 1980 – as its role as an inflation hedge grew. The red line in the graph below is where Paul Tudor thinks the price of Bitcoin may be today.

    So, what’s to come?

    CME Bitcoin Futures have seen 567 new accounts start trading their contracts in the first quarter of 2020, which is more than double the amount of Q4 2019. Meanwhile, the Open Interest in the market has reached an all-time high with 66 new “large traders” (traders with positions exceeding 25 BTC).

    In addition to Jones, Renaissance Technologies – a $75 billion US-based hedge fund – has made clear that its funds are now “permitted to enter into bitcoin futures transactions” via CME. Open interest across CME Bitcoin markets from hedge funds has additionally hit a 10-month high, according to data compiled by The Block, hitting $150 million on May 5.

    “The best profit-maximizing strategy is to own the fastest horse. If I am forced to forecast, my bet is it will be Bitcoin.”


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