How the US Marshal Bitcoin Auction Affects the Market

Hi, I’m Kevin Zhou, Economist at Buttercoin a Silicon Valley / Wall Street backed Bitcoin Marketplace (sign up here).  Every week we take a look at what’s happening in Bitcoin and share it, here’s the latest. 

This week markets traded between $365/BTC and $385/BTC.  Volatility has remained low with the exception of a sharp but minor drop on 12/4 from $375/BTC to $365/BTC.  Trading volumes continue to decrease.

News this week:
  • Second US Marshal bitcoin auction closes: http://bit.ly/1vxswoF
    • 50k BTC were auctioned off.
    • 11 bidders present.
    • Tim Draper wins 2000 of them.
  • In an Australian Senate Economics Committee inquiry, Mastercard argues for stronger regulation of bitcoin: http://bit.ly/1vFPRJP
  • Coinjar relocates to the UK due to unfavorable bitcoin tax environment in Australia: http://bit.ly/1ubRj2f
  • Rep. Steve Stockman introduces bill to impose a moratorium on new legislation regarding cryptocurrency for 5 years: http://bit.ly/1I5hK2T
    • Also calls for bitcoin to be treated like a currency.
    • For tax purposes, the creation or purchase of bitcoin is not immediately taxable based on "fair market value" but only taxable after converting to fiat. Only then is net gain/loss calculated.
  • 3 top Dutch banks experiment with blockchain technology: http://bit.ly/1w6CQce
  • Venezuelan congressman Guido Ochoa buys HashFast in bankruptcy sale: http://bit.ly/1G9c2JI
  • Blockchain.info's random number generator was compromised for a brief moment yesterday resulting in unsecure private keys being generated on behalf of customers: http://bit.ly/1wUbOGO
    • Losses total around $100k.
  • BTCT and owner/operator burnside fined $68k by SEC for violating securities laws: http://bit.ly/1vFPXkT
  • A good explanation of block withholding attacks on open pools: http://bit.ly/1w6CTon
    • Open pools are intrinsically vulnerable to block withholding attacks by solo miners and other pools.
    • This can be somewhat mitigated by giving a disproportionally larger reward to members which find the actual block in a pool but it cannot be completely solved for open pools.
This week, I'd like to delve into the second US Marshal bitcoin auction and how it affects the market.  Markets should only react to new, unexpected information.  The expectation that these Silk Road seized coins would be auctioned off by the government had already formed to some degree on the day the coins were seized and further confirmed by the first US Marshal bitcoin auction.  Thus the event of the second auction, itself, should have little market impact because it was, with near certainty, expected by the market.

There are broadly two types of bidders in the auction.  Those who bid under market price (short and long-term value seekers) and those who bid above market (long-term investors).  If an underbidder wins, they could either sell the bitcoin into the open market to lock in some profit or hold onto the bitcoins for a longer period of time.  Both of these behaviors are reasonable.  However, if an overbidder wins, the only reasonable behavior is to hold.  This is because the only reason someone would bid above the current spot price is because they are seeking to take a sizable long position in bitcoin while incurring less slippage than if that position was bought in the open market.  There would be no reason for someone to bid above market price only to win the auction and immediately it sell back to the market at a loss.

Therefore, if an overbidder wins, we can be reasonably sure that those coins will not be dumped onto the market and create selling pressure.  If opinions about the market are distributed between pessimistic on one side and optimistic on the other, you would expect that some people belong to the pessimistic side and some others to belong to the optimistic side and most people are in the middle.  If everyone was on the price-pessimistic side, some of them would just sell into the market until both sides become roughly balanced.  So of the 11 bidders, we can expect some of them to be underbidders and some of them to be overbidders.  This is expectation is amplified by the fact that some of the 11 bidders represent syndicates composed of many smaller bidders who all likely have differing sentiments about bitcoin price.  A lopsided 9-2 split is more likely to happen purely by chance than a 900-200 by chance.  In light of that, I expect most of the auctioned coins to be won at above market price and for those coins not be be dumped for some significant time.

Up until now, we've considered how auction winner behavior affects post-auction price.  How about the effect of expected winner behavior on pre-auction price?  If we expect most of the auction to close above market, does that lead normal market participants to buy and pump up the price knowing that there will likely be someone who bought at a higher price than them, who will not sell below that price?  Intuitively that might make sense but I would argue that it can't be the case.  Overbidders by definition are willing to pay more than the rest of the market so the reciprocal is also true: the market is only willing to pay up to a point less than the overbidders' price point.  The market sees the overbidder as overpaying in a sort of short-term winner's curse even if the overbidder ends up being right in the long run.

Therefore, I think we can reasonably assume:
  • The market expected the government to auction off those coins and continues to expect that the rest of the seized coins will be auctioned off at some time in the future.
  • A significant majority of the auctioned coins sold at a premium to market price.
  • Those coins won above market price will not be dumped in the near future.
  • Market price is a better reflection of short-term "true value" than the price at which the auction closes.
The last thing we haven't considered is that some bidders could trade on the open market leading up to the auction to influence the market price and subsequently the auction closing prices.  This is worth exploring further.

Cheers,
Kevin & Team Buttercoin
Bitcoin Trading Made Easy | Buttercoin.com

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