Friday, January 24, 2014

Bitcoins: Embrace or Beware?

A fad or the real deal?
Let's not beat around the bush about Bitcoins, the digital currency that has stirred up the financial world the past year or so.   

Bitcoins are a virtual currency, now accepted by some merchants and commercial enterprises as a form of payment for services or products. Because Bitcoins have a fluctuating market value, many try to exploit price volatility and treat Bitcoins as an investment--similar to investors who might purchase foreign currencies with hopes that volatile swings will result in handsome profits.

However, most participants are still not sure how Bitcoins came to be, who or what oversees the marketplace, and where all this is headed.  Let's be real. Any purchase or investment in Bitcoins is a speculative investment.  Uncertainty, volatility and mysterious (or mystical?) origins offset confidence prudent investors or users for payment purposes might have in its legitimacy.  As we saw in late 2013 when the Chinese government intervened to discourage its use, Bitcoins are enveloped by the unknown, and investors run for the hills when they sense something odd or peculiar in this marketplace.

This is a marketplace where even the most active participants are not sure the founder is one person with a vision for an online payment system or a horde of computer jocks out to amuse themselves. It’s a marketplace in its infancy.  As of mid-Jan., 2014, this is a $10 billion market with less than a million Bitcoins (BTC) traded or transferred daily.

Time will tell whether they will become a reliable currency for the long term.  Time will also tell whether this is a finance fad of the early 2010's or a landmark turning point in the history of monetary systems.

Transactions, trading and investing in Bitcoins are a global phenomenon now. A curiosity for some.  Just a year or so ago, the value of a Bitcoin was around $300. During the year, prices soared to $1,000, sank quickly to $500 last fall and then surged and stumbled again like laundry tumbling and churning in a dryer. (They were valued at about $780 in mid-Jan., 2014.)

Some argue Bitcoins (or their off-shoots or similar virtual versions) are here to stay. Bitcoin activity will be propelled by transactors attracted to a system that knows no boundaries, is not directed by government bodies or political systems, and allows for trades and payments in relative anonymity.  As with most financial trends or fads, this phenomenon is bound to stray in some direction--up or down, up and down, out of existence, or perhaps eventually into a nightmarish tangle of fraud, misrepresentation and legal quagmire.

For now, let's acknowledge what seems to be happening in early 2014:

1.  The price movements and upward, secular trend in value have attracted speculative investors around the world.  

Whether they believe in the system or are proponents of a politics-free, digital market for payments, they see opportunities to make money in the short term. If the price increased from $300 to $1,000, why wouldn't it increase to $2,000 over the next year or two--especially if popularity continues the current course?

Speculative investors may not care much for the algorithms and calculations that influence a Bitcoin's value. They see trends in growing demand and popularity, not always sufficiently explained, and a grand opportunity for a windfall.

2.  There appears to be a growing acceptance by some merchants and businesses to accept payment in Bitcoins (BTC).

Growing acceptance offers legitimacy and comfort to consumers who choose to participate in the system.  VirginAtlantic, the airline, joined this group late last year.

In some ways, an increase in participating businesses helps boost liquidity in the system and encourages other participants to join.  The growing number of participants may eventually cause a cry for more transparency and oversight--which exists today, but in veiled ways.

3.  A Bitcoin market depends on a class of participants called "miners," who act somewhat like "brokers" or "market-makers." 

In financial markets, brokers or market-makers facilitate and process trades. Rewarded with commissions or marked-up profit spreads, they have incentives to keep a market alive, active, and liquid.  In the Bitcoin world, miners act in that role.  Like many financial markets, Bitcoin "miners" have sprouted everywhere in surprisingly large numbers, partly because of the lure of rewards ("commissions") and partly because mining Bitcoins could be considered less risky than in investing in them.

Before others leap to join the ranks of miners, note the odd wrinkle in miners' responsibilities. Miners secure, confirm and report Bitcoin transactions. They are compensated by being rewarded with a special new supply of Bitcoins, but only after they have successfully solved a math problem that requires enormous amounts of computer power.

Think of a financial broker being rewarded with an incremental new issue of a company's stock.  Or think of the Federal Reserve rewarding big banks who confirm and expedite money transfers with new-money credits at the Fed. However, imagine being paid for the service only after solving a math problem that--by Bitcoin rules--will become more difficult to solve in the future.

Those who have access to such computing heft have opportunities to reap substantial rewards. Like market-makers and brokers in a financial market, they facilitate transactions without taking on significant amounts of investment risk. (Their initial investments are those in computer servers or in space that houses computers.)

Because they bear a little less risk than speculative investors, a cottage industry of miners (and related businesses) has surfaced in global corners everywhere--from California to Iceland. There are miners, but there are also companies that support miners by selling or leasing access to computers for mining purposes. There are investors (including private-equity firm Andressen Horowitz) that are now comfortable investing in "mining" operations.

4.  Bitcoin "money supply" is controlled, and growth is restricted, planned and charted, based on an initial algorithm. 

BTC coin supply is based not on economic policy or economic objectives, but on the complex math calculations miners are required to do with their high-power computers. 

By design, the more successful miners are in finding solutions to the calculations, the more difficult the next series of calculations becomes.  It becomes harder and harder to solve the problems to get the same reward. Miners will, therefore, invest in greater computing power to earn similar revenues. Today, miners are racing to grab revenues that might be near impossible to generate a few years from now. And racing like mad.

Those calculations have less to do with how central bankers manage monetary supply, more to do with the calculating power of their computers. Governments and central bankers, we observe, manage monetary growth based on objectives they have regarding interest rates, inflation rates, and expected economic growth.  "Money supply" is ultimately finite in the world of Bitcoins. Until supply reaches a determined maximum, it is now  determined by activity, participants, and computer power. 

5.  While "mining" helps ensure the Bitcoin market is an orderly market, nobody yet knows what will happen in the worst of cases.  

If there is a sudden crash in price --a sudden collapse or a widespread panic, who will oversee the marketplace? If there are crises or disruptions caused by technology, systems or deceitful miners, who will act to revive trading and transacting? 

6. The  system, which eased quietly into the global financial system within the past few years, will continue to attract participants--not because libertarians enjoy that governments have no part to play, but because of money-making opportunities.

A steady increase in legitimate participants may eventually force the system throughout--not just in segments--to provide a blueprint for how the system will behave in worst-case scenarios.  Furthermore, crises, disruptions and crashes will have inevitable legal implications, which of course will require governments or courts to intervene in the end.   

For now governments and central bankers have been shunted aside. The system is self-policing. But the greater the number of participants and the greater the likelihood for system mishaps, then the greater the push for order and protocol that would boost confidence in the system.

But will all that occur before the system's first panic crash, the shocking catastrophic plunge that will cause large numbers of participants to flee en masse with no confidence in ever returning?

Or will the system, supported by a phalanx of miners around the world, find ways to keep itself honest, fair, and relevant?

Tracy Williams

Tuesday, January 14, 2014

What Will 2014 Bring?

Equity markets: More of the same in 2014?
If the year 2013 ended with moods, markets and sentiments on an upswing, what's on deck for 2014?

What will happen in the upcoming year? What is the agenda for banks, investment managers, hedge funds and an assortment of institutions in financial services?

Let's first sort through equity markets. Last year, we saw blockbuster returns--over 25%, depending on the index you follow. There were the usual dips, dives and concerns, but by autumn, equity markets continued to edge upward. Anybody's diversified portfolio of stocks performed well. The upbeat markets reflected perceptions by many (traders, investors, bankers, et. al.) that we had climbed out of the financial crisis, that the economy had finally reversed course, and that we could confidently move on.

But market returns above 20%, for some portfolio managers and investment gurus are nothing to rave about. They become headaches, causes for concern.  Are we headed toward another bubble, another 1987, 1998, or 2008? A debilitating nose-dive after periods of euphoria has happened before (more than once), so it can (or must?) happen again. How should we interpret recent discouraging data about net job increases across the country? What will the Fed do (or not do)?

For many in finance, 2013's soaring returns are a warning signal that we should be cautious about an impending bubble burst or should at least dissect market trends or economic behavior that portends a market slump.  Market prognosticators who see doom on the horizon are not necessarily nay-saying pessimists. After everybody was struck by knock-out blows of the last crisis, market participants just want to be prepared for the next time.

From now until about midyear, traders and research analysts will observe every move of new Federal Reserve Chair Janet Yellen, even if many have described her as a Bernanke disciple, someone loyal to a course of maintaining low interest rates and continuing the Fed's program of bond purchases.  Some experts say this such Fed strategy explained much of last year's upturn and any plan to deviate from this could upset stock markets.  

In 2014, in equity markets, if we don't see continuing upswings, we will see more structural changes in the way stocks are traded. Over the past decade, there have been structural overhauls in stock trading. Major stock exchanges (NYSE, Nasdaq) are no longer stoic boys' clubs that monopolize among themselves  transactional volume. They have had to change, adapt, and be aggressive to stay alive. They compete with lightning-quick electronic exchanges, "dark pools" (run by major financial institutions), high-frequency traders, and markets that have no end of day. They must offer low fees and nano-quick execution or become less relevant.  

So in 2014, the heralded New York Stock Exchange struggles to find a role in the chaotic stock-trading sphere. It is no longer independent. A few years ago, it considered diversity and expansion by acquiring European exchanges and becoming NYSE Euronext. As it struggled to adapt, appease shareholders and remain profitable, it allowed an upstart electronic-futures exchange, ICE, to take it over.  Now in the upcoming year, ICE wants to dismantle parts of NYSE, hinting that it acquired NYSE mostly to grab the futures and commodities arms. It will likely hold onto NYSE as a badge of prestige, while the NYSE goes head to head with other electronic newcomers and trail-blazers.

The overall agenda for 2014 is otherwise assorted--a range of items and issues that must addressed, tweaks here and there.   

Financial regulation continues into what might be phase three--more implementation,  a few more rules, and widespread adjustments by banks, traders, funds and regulators before we head into years of strict enforcement.  Perhaps the year will finally bring more clarity in derivatives trading--exchange trading, clearing vehicles, and over-the-counter rules.

On the legal side, last year's insider-trading scandals continue through the court system. Federal prosecutors suggest there could be more indictments, although they may not match the headlines from accusations, indictments and settlements at SAC Capital.  In this realm, Round 1 involved the hedge fund Galleon Group.  Round 2 brought us SAC Capital and settlements involving its founder Stephen Cohen.  Round 3 will unfurl in the year to come, could involve others in an intricate, tangled trading network, but may not expose familiar, big names.

Global banks performed well last year, but their investment-banking units had less reason to celebrate in 2013. IB revenues across the board sagged at most places. Banks have been mired in IB restructuring (as banks adapt to Volcker rules and capital requirements), and their clients continue to approach the economic horizon with caution. Indeed in 2013, there was a welcome spate of IPO's, big deals, and debt offerings. But clients have been hesitant about expanding too far too fast, shy about acquiring other firms or doing big mergers--all frustrating investment-bank leaders. M&A activity, which suggested a back-to-glory-days trend last summer, has slowed to an ordinary crawl. Some call it humming, normal activity. Others call it doldrums.

Nevertheless, like all years, it's easy to capture and describe current moods (renewed, cautious confidence), but hard to project a specific event that could be the domino that causes market unrest. Experienced market participants and risk managers know it takes one or two correlated events to change abruptly a bright, comfortable course, one event that could pummel 2013's optimism from its pedestal.

Let's hope in 2014 no Russian debt crisis, no Bear Stearns mortgage wipe-out, no unsettling, triple-witching-hour trading day, no Long Term Capital portfolio implosion or no Drexel-like junk-bond circus looms to erode the era of good feeling 2013 brought.

Tracy Williams

See also:

CFN:  Looking Back at 2013
CFN:  Cliffs, Recoveries, Outlook for 2013
CFN:  Where Do You Want to Work in 2013?
CFN:  Opportunities in 2012
CFN:  Approaching 2012

Thursday, January 9, 2014

Yale SOM Gets a New Look

Yale SOM's Evans Hall opens up in January (NH Register photo)
Yale School of Management, one of the Consortium's 18 schools, is opening up a new campus facility, Evans Hall, in New Haven in mid-Jan., 2014.  The school will launch the new state-of-the-art building with receptions, lectures, presentations and celebrations of what has made Yale SOM special and unique among the panoply of business schools. The week's theme is "Leadership in an Increasingly Complex World."

The new campus will feature the marvels of business-school technology and covers 242,000 square feet, at a cost of $240 million, much of which was made possible by benefactor Edward Evans, who was an undergraduate student at Yale and later CEO of Macmillan, Inc., the publishing house. Besides interview rooms and three libraries, it will even have a student gym and entertainment space.

Yale's dean, Edward Snyder, migrated to Connecticut in 2011 from Chicago's Booth School of Business. In the midst of Chicago's Gothic maze, Booth is a modern, self-contained business school campus, the kind of campus Yale SOM students and faculty might have envied.  Once Snyder arrived in New Haven, he spearheaded the completion of a new campus, a new facility featuring the latest business-school bells and whistles. And his experience in helping to open Chicago's new doors no doubt got many SOM faculty, alumni and students excited about a new campus for Yale.

Building modern facilities is a frequent occurrence at top business schools.  They know that to attract top students, schools must pay attention to their physical being. Facilities, campus and amenities sometimes rank as high as innovative course offerings, curriculum, career placement and notable faculty when students decide whether or not to attend.  While Yale SOM attracted top students over the past decades, many alumni and school leaders felt that an impressive, separate campus was necessary to lure the student that might otherwise be more interested in attending Wharton or Harvard.

Yale and Chicago are certainly not the only schools with new campuses.  Stanford now has its new Knight Management Center, home to its business school since 2011, featuring courtyards, magical classroom technology, chic ambience and sunlit, outdoor cafe settings.  Wharton and Consortium school Michigan have also opened new campus facilities.

Yale SOM has had a colorful history. When it was launched in the mid-1970s, it wanted to be different from other schools. It offered a management-education mixture of the public and private sector.  The degree it certified upon its graduates then was the "MPPM"--a master's in public and private management, arguably a combination of the MPA and MBA degree. Graduates would be steered toward Morgan Stanley, the World Bank or Capitol Hill. At one point, the "O" in "SOM" stood for "Organization."

At times, alumni, recruiters, employers and other constituents interpreted the degree in many ways. And at times, new deans pushed the emphasis one way or the other. Eventually SOM settled on the MBA degree, and it has tweaked the definition of what that means from time to time. In its first three decades, Yale SOM didn't have a separate facility, but existed in a pleasant, neighborly network of "houses" on Yale's Hillhouse Ave.

The new Evans Hall reinforces the notion that Yale SOM has become a top business school in a classical way, although the school, more than many others, tends to walk and run to its own drumbeat by remaining small and enjoying experiments with new ways of instruction or new approaches to the MBA experience. Its integrated curriculum is its latest novel approach.

Yale joined the Consortium in 2008 and has graduated dozens of Consortium MBA's since then. 

Yale being Yale, the school and new facility will seek to fit in well with the rest of the Yale campus.  Evans Hall, with blue hues, courtyards and exquisitely selected artwork, wants to be identifiably Yale, circa 2014.

Tracy Williams