Bitcoin’s plunge sparks high drama on Wall Street

Bitcoin's wild ride, as price plummets

As the clock ticked past midnight (AEST) and in the early hours of May 20, sleep in Australia was at a premium. The bitcoin price had slumped below $US31,000, which was half its level of just over two months ago.

Losses were headed towards $US1000 billion mark. Was this the end of bitcoin or was it too big to fail? Over in New York they would discover just how deeply embedded bitcoin has become in the financial future of Wall Street. Indeed perhaps it is too big to fail.

During 2021 there have been two very large bitcoin buying groups. The first is the youngsters (usually aged in their late teens or 20s) who have been able to buy bitcoin on huge leverage. Borrowings exceed 90 per cent and often get close to 100 per cent. Many young traders believe this is part of a transfer of wealth to the next generation.

While the young traders who bought bitcoin were big losers, it was the lenders to these youngsters who on paper had lost most of the $US900 billion.

The second group of major buyers are the Chinese, who love a gamble and for whom bitcoin seemed a politically neutral trading counter.

A bitcoin ATM in New York. Picture: AFP

This week’s fall in bitcoin was triggered by the Chinese government redoubling its crackdown on bitcoin and cryptocurrencies, which helped fan doubts about their future.

The Wall Street drama was played out at the highest level. To understand the intensity I have to take you back to February this year. It was a time when interest rates were at token levels; Joe Biden had said he would take on huge amounts of debt and Wall Street share valuations did not appear to take into account the dangers.

Many institutions were becoming desperate for a place to invest their money and gain big returns. And so in February numerous big investors, including the world’s largest money manager BlackRock, Goldman Sachs and Morgan Stanley all boldly announced plans to trade bitcoin and invest it on behalf of selected customers.

Tesla, via its chief Elon Musk, was also revealed as a buyer of around $US500m in bitcoin. Both Visa and MasterCard said they plan to add cryptocurrencies to their payments networks following the December announcement by PayPal to allow US users to buy, sell and hold crypto.

Not surprisingly, in March, bitcoin prices had soared beyond $US64,000, valuing the total currency market at around $US1.8 trillion. Other cryptocurrencies also skyrocketed.

Many of the big players didn’t just buy bitcoin but became involved in the complex web of derivatives that funded part of the enormous debt associated with the bitcoin market.

When Wall Street opened on Wednesday, those at the highest level of Wall Street saw forced bitcoin sales mounting along with the lender losses. Many feared the derivatives web would be severely damaged by the bitcoin losses.

Elon Musk had appeared to suggest Tesla was planning to sell its huge holding of bitcoin, before clarifying the company had not sold any bitcoin. Picture: AFP

There is no doubt that if bitcoin had continued to slide the damage to global derivatives would have been severe and impacted confidence in the world banking community. Perhaps realising the dangers, the big buyers came in and turned the market.

Later in the day Bitcoin was surging above the so-called safe level of $US$40,000. Wall Street shares which had fallen with bitcoin recovered most of their losses. At least for the moment the crisis was over, although as trading concluded there were new waves of selling which again took bitcoin below $US40,000.

In addition to the China actions, another trigger causing the Bitcoin fall was the apparent decision of Elon Musk to sell some of Tesla’s $US1.5bn bitcoin investment. Tesla shares became hooked to bitcoin because Musk did not sell all his bitcoin stock.

Watching the drama was Wall Street legend Michael Burry, who back in February and March had shorted Tesla shares around the $US800 level. Delighted, he watched Tesla shares in the early hours of May 20 trading close to $US550—he had made yet another killing.

Burry became famous betting against mortgage securities before the 2008 global financial crisis. He made a fortune.

Michael Burry, Picture: Bloomberg

Burry was depicted in Michael Lewis’s book “The Big Short” and the subsequent Oscar-winning movie. One of the reasons Burry shorted Tesla was that he believes that Tesla’s reliance on regulatory credits to generate profits is an impediment to the company’s long-term future.

I do not know the detail of Burry’s motivations and strategies but my guess is he would have seen Tesla’s bitcoin play as a way for Musk to offset the weakness Burry had isolated and which triggered his short position.

Meanwhile, as bitcoin prices were falling, many recalled the warnings back in February of Berkshire Hathaway’s Charlie Munger and the then incoming Treasury secretary Janet Yellen about the destabilising effects of a bitcoin bust.

But the most joy in the bitcoin troubles comes from those who have bet on gold as a hedge against massive central bank money printing.

Bitcoin had taken many buyers away from gold but the latest turmoil has them rushing back to the yellow metal, which is creeping up higher and higher. Until recently that rise in gold had been duplicated in many other metals, led by copper as the world’s industrial activity quickens.