Is Bitcoin Too Big to Fail?


Just before the last bitcoin bubble popped, around the time socialite Paris Hilton issued her own "digital token" and idealists and amateurs across the globe were still tipsy on the idea of circumventing Wall Street, central banks and the usual billionaires with new digital currencies, Mike Novogratz was finishing up a talk at a cryptocurrency conference in New York City.

Novogratz, a former Goldman Sachs executive turned bitcoin advocate, had given many such speeches before, usually to an audience of staid financial types. This time, however, he stepped off the stage to a mob of millennials and a rock star's greeting. "Literally pictures, pictures, pictures," he says. "Everybody wanted a selfie. Some girl came up and started quaking, 'Can you sign this?' It was really weird."

"So I started selling."

It was a smart move. By 2019, bitcoin, a famously volatile digital currency, had dropped to less than $4000. In recent months, however, it has once again started a steep upward trajectory. It rose from $11,000 in September to $24,000 in December, passed $40,000 in January and hit $61,000 in March—more than three times its 2017 peak and 19 times its most recent low in 2019—raising fears of yet another bubble.

But this time around, things are different in at least one respect: It's not just the hoi polloi who are powering the cryptocurrency's rise. The financial establishment has also added its considerable fuel to the bitcoin rocketship.

With interest rates hovering around zero, governments taking on trillions in COVID-stimulus debt, and stock valuations reaching levels that some investors consider absurd, corporate chieftains and institutional investors have grown increasingly desperate for a place to stash their money. In February, big investors—including Tesla-chief Elon Musk; BlackRock, the world's largest money manager; and banking powerhouses Goldman Sachs and Morgan Stanley—revealed plans to trade bitcoin and invest it on behalf of some customers. Both Visa and Mastercard said they plan to add cryptocurrencies to their payments networks following the December announcement by PayPal CEO Dan Schulman to allow U.S. users to buy, sell and hold crypto. Billionaire Mark Cuban has also endorsed bitcoin.

SpaceX owner and Tesla CEO Elon Musk: a $1.5 billion bet on bitcoin. Hannibal Hanschke/Pool/Getty

What the arrival of the smart-money set means for the long-term viability of bitcoin and other cryptocurrencies—and for the future of gold and traditional forms of government-issued paper money—remains an issue of intense speculation and debate. Policymakers and economists such as Berkshire Hathaway's Charlie Munger and incoming Treasury Secretary Janet Yellen have warned about destabilizing effects of a second bitcoin bust, which could wind up vaporizing the wealth of regular investors caught up in the frenzy—the bitcoin market is worth about $1.78 trillion. The policy mandarins have revived talk of previous speculative bubbles like the 17th century Dutch tulip mania, the disreputable past of cryptocurrencies as a medium for the criminal underworld and the energy consumption needs of the continuously-updating, globally-distributed, 10,000-node computer network used to mine bitcoin and track the ownership of the roughly 18.7 million bitcoins currently in circulation.

Even if these fears fail to materialize, the upside is not exactly comfortable, either. If bitcoin continues its rise as an independent currency, loosely regulated and beyond the reach of local law enforcement and central banks, it could disrupt the world's financial order and make it far more difficult for governments to juice their economies by tweaking the local money supply. The embrace of the big banks and investors could have potentially profound consequences, for better or worse, for the future of money and banking. Which is why U.S. regulators recently proposed a series of stringent new disclosure requirements for entities that sell cryptocurrencies, the Chinese government began testing its own form of digital money and, in March, Indian lawmakers proposed requiring investors to liquidate their holdings in cryptocurrencies like bitcoin within six months and, thereafter, criminalizing possession.

Cryptocurrency cheerleaders like Novogratz, however, say that the killjoys are too late: the die is cast, bitcoin is here to stay. "Seventy-five percent of the world's wealth is owned by 50- to 85-year-olds who buy the investment products of the mainstream players," he says. "Most of the crypto growth until now has come from young people. But we're about to hook this giant pipe up to the wealth of the world."

Not everyone is so sure. A recent Citigroup report suggests that the financial world now stands between two possible futures. Bitcoin "balances at the tipping point of mainstream acceptance or a speculative implosion," Citigroup's analysts say. "Developments in the near term are likely to prove decisive."

In other words, 2021 is shaping up to be the most consequential year in the colorful 13-year history of bitcoin.

"The shift of psychology didn't happen overnight," says Novogratz. "But the dam finally broke, and the dam broke in the last three months and it feels awesome that the dam broke."

The Legitimization of Crypto

It's not much of a stretch to suggest bitcoin was invented in anticipation of precisely the current economic scenario.

When the mysterious computer engineer Satoshi Nakamoto formally launched the bitcoin network on January 9, 2009, he embedded a message among 31,000 lines of computer code that was impossible to miss: "Chancellor on brink of second bailout for banks," it read, referring to a front-page article in the London Times published the previous week.

The headline highlighted the most obvious justification for bitcoin's adoption. In the wake of the 2008 financial crisis, central bankers across the world were flooding the markets with new currency, tamping down interest rates and spending billions to stabilize the economy in an effort to stave off a global depression—as they've done during the pandemic. Nakamoto's new digital money was designed as a way for individuals to protect themselves from the inflationary pressures many believed would inevitably follow—a safe harbor impervious to the machinations and whims of any one government, economy or currency.

To protect his digital tokens from outside influence and ensure its global adoption, Nakamoto created an incentive structure aimed at getting computer users around the world to install his software and join a continuously updating, globally distributed network of computers that existed beyond the regulatory jurisdiction of any government. Each computer "node" would house its own copy of a ledger that tracked the location and transfer of every unit of his digital currency and would be updated with "blocks" of new transactions written and added, at regular intervals, to the "blockchain." In exchange for their participation in the creation and maintenance of this unhackable "distributed ledger," the owners of each blockchain node would be entered in a virtual lottery, eligible to win a piece of the next batch of computer-generated "bitcoins"—essentially a piece of encrypted code. Bitcoins would be produced and released to the world on a fixed time scale until the total supply reached 21 million, at which point those who work to maintain the blockchain would be compensated with small transaction fees.

In 2010, after a few months collaborating virtually with other developers online to fine-tune the source code, Nakamoto announced he was "moving on to other things." Then he disappeared.

The creation he left behind has been growing in popularity ever since. Initially, it was embraced by a motley coalition of crypto-anarchists, libertarians and idealistic Silicon Valley engineers. It also captured the imagination of a wide array of disreputable individuals, attracted to the anonymity and ease with which bitcoin can be transferred online, looking to conduct illicit activities outside traditional financial channels. Indeed, many Americans first heard of bitcoin when the FBI took down a massive online black-market-drug bazaar known as Silk Road in 2013, where bitcoin was the currency of choice.

A few weeks after the Silk Road bust, Novogratz became, quite by accident, the most well-known Wall Street figure to suggest that these obscure digital tokens might actually have some value.

Bitcoin advocate Michael Novogratz Justin Hoch/Galaxy Digital

As Novogratz tells it, during a panel discussion, someone asked for his opinion on investing in the currency of small, obscure nations. At the time, Novogratz, a trim 50-something former Princeton wrestler with a square jaw, shaved head, piercing blue eyes and the coiled swagger of a real-life Bobby Axelrod, the hedge fund protagonist of HBO's hit series Billions, was a member of the New York Federal Reserve's investment advisory committee on financial markets, as well as co-chief investment officer of macro funds at the $55-billion Fortress Investment Group.

As it happened, he had recently sunk $3 million or so of his own money into the exotic new currency, which at the time was trading below $100 a coin. It was an entirely speculative investment—so speculative that he and a colleague at the fund concluded they couldn't in good conscience risk the firm's money on it.

Novogratz then made a case for why bitcoin could go from $100 to $1,000. Among them: The Chinese seemed to like it, and there were a lot of them; the currency had captured the imagination of a small group of crypto anarchists who were in buying mode; and people were increasingly angry with the policies of the U.S. Federal Reserve Bank and worried about hyperinflation.

Novogratz woke up to find himself on the cover of the Financial Times under the headline: "Bitcoin endorsed by top hedge fund manager." He was besieged with requests from reporters to appear on television and to give speeches—a testament to just how unusual his views were at the time. He was immediately part of a small group of experts on the burgeoning industry. When bitcoin reached $1,000, turning his $3 million stake into $30 million, Novogratz considered selling it to buy a jet. A colleague at Fortress wisely talked him out of it.

In 2015, with his hedge fund down after a series of bad currency bets, Novogratz left Fortress and sold his stock in the firm. Flush with cash, sidelined from mainstream finance and suddenly adrift, he reached out to an old Princeton chum, Joe Lubin, who had recently founded a firm, ConsenSys, to build blockchain applications. When the newly-unemployed Novogratz went to visit Lubin at the ConsenSys office in Brooklyn shortly after it opened, "that was my breakthrough moment," he says. "I was like, God damn it, this is not just a trade. This is a revolution."

Of course, revolutions are often preceded by bubbles. Which is why, soon after he was mobbed at that 2017 conference, Novogratz says he began liquidating his bitcoin stake. In January 2018, he launched Galaxy Digital and set his sights on winning mainstream acceptance for crypto, which he had come to believe could become a permanent asset class. He hoped to build his company into the "Goldman Sachs of the crypto world" that offered trading, advisory services and investment banking from "the smartest guys in the room."

(Full disclosure: the last time I wrote about bitcoin for Newsweek, in early 2019, I found Novogratz's argument so convincing that I got swept up in the frenzy. After my story ran, I made a token investment in his company in my 401(k) as well as a portion of a bitcoin. I promptly watched it all plummet in value.)

Novogratz knew that the biggest obstacle to institutional adoption was bitcoin's disreputable, shady past. So early on, he sought to achieve legitimacy for the cryptocurrency. He and his team persuaded former New York City Mayor Mike Bloomberg, whose media company has 300,000 subscribers to its signature terminal business, to launch the Bloomberg Galaxy Crypto Index, which provides real-time data tracking the price of nine cryptocurrencies, including bitcoin, ethereum and XRP, among others. The index also lends the currencies some credence.

"People are like, 'Wait, this is a real thing if it's on a copy of Bloomberg,'" says Novogratz. "That sounds small. It's not small. It's how you take something that came from the fringes and make it mainstream."

After Bloomberg launched the index in May of 2018, Novogratz fanned out for meetings with Wall Street executives to explain how bitcoin works, why they should invest in it and why it is more than simply a tool for money launderers.

Mainstream players started to get into cryptocurrency shortly after the first bubble burst. New companies sprang up aimed at building up infrastructure that would be necessary for institutions to invest in bitcoin. One of the most prominent was an exchange unveiled in August 2018 by Jeffrey Sprecher, chairman of Intercontinental Exchange, which owned and operated the New York Stock Exchange and 25 others. Sprecher formed a company, Bakkt, along with his wife and future U.S. Senator Kelly Loeffler, who would serve as its CEO, and sought regulatory approval to trade bitcoin-based futures contracts. The support of Sprecher's company was a win for cryptocurrency advocates. The exchange began trading futures in September 2019, and by the following September was trading as many 15,955 bitcoins a day, valued at $200 million at the time of the announcement.

Other investors also jumped in. Tyler and Cameron Winklevoss, of Facebook fame, had debuted the Gemini Trust Company, which they would build into a major crypto exchange, in 2015. The company worked with New York State to win a stamp of regulatory approval—a whiff of the "rigor of traditional finance" that helped shake off crypto's outlaw image, says Noah Perlman, Gemini's Chief Operation Officer. In 2016, Gemini became the first officially licensed exchange in the United States for ethereum, another cryptocurrency, after Governor Andrew Cuomo announced his approval.

Gemini's recruitment of Perlman, who joined the firm in October 2019, initially as head of compliance, was another boost for crypto advocates. As a former lawyer for the Drug Enforcement Agency, assistant U.S. Attorney and Morgan Stanley Managing director, Perlman was no stranger to the law enforcement angle—he knew how drug dealers and money launderers used bitcoin to evade authorities.

Perlman was one of many examples of how crypto companies have hired blue chip talent with regulatory backgrounds to help them win legitimacy. In 2018, Coinbase, an $8 million Silicon Valley-based digital crypto exchange that filed for a public offering last week, hired Brian Brooks to serve as its chief compliance officer. Brooks, a former managing partner at the Washington, D.C., office of the legal powerhouse O'Melveny & Myers, had close ties to the banking industry and had served four years as executive vice president, general counsel and corporate secretary to Fannie Mae.

In 2020, after two years at Coinbase, Brooks joined the U.S. Office of the Comptroller of the Currency (OCC), as senior deputy comptroller and chief operating officer, a powerful government perch from which to promote the industry's interests. Charged with ensuring the integrity of the U.S. banking system, the OCC is the sole U.S. institution with the authority to grant a national bank charter and determine what constitutes a bank. They can also withdraw it from institutions that fail to follow the rules. Roughly 70 percent of U.S. banks are regulated by the OCC.

Under Brooks, the Office of the Controller of the Currency issued a series of "interpretive letters" that have a gone a long way toward reassuring banks concerned about the legality and risk associated with cryptocurrency, says Kristin Smith, executive director of the Blockchain Association, a Washington, D.C.-based advocacy group. The letters clarified that banks can legally store the bitcoins held in "digital wallets" for their clients, connect computers to the digital bitcoin ledger and establish their own individual blockchain "node."

In January, the OCC for the first time granted a national bank charter to a firm, Anchorage, which means it can act as a crypto custodian, holding crypto on behalf of its clients. Soon after, the OCC issued a similar grant to Protego. These actions served notice that the crypto institutions were now operating within the government's regulatory system as legitimate entities subject to the customer protections and oversight seen in traditional finance.

"Those types of actions coming out of the OCC sent a really positive signal that crypto is here to stay," Smith says. "They were really important."

These efforts go a long way to explaining why attitudes toward crypto on Wall Street and the rest of the financial establishment have changed dramatically in recent months. In addition, late last year Wall Street thought leaders such as Paul Tudor Jones and Stanley Druckenmiller revealed that they own bitcoin, making the case that bitcoin was no longer something to be ashamed of.

That set the stage for February, when crypto took a quantum leap into the mainstream. Rick Rieder, the chief investment officer of BlackRock, acknowledged for the first time that his firm, the world's largest asset manager, had started to "dabble in bitcoin." Morgan Stanley began buying bitcoin for some customers and revealed it had taken a 10 percent stake in MicroStrategy, a NASDAQ-traded software company holding billions of bitcoin on its balance sheet. Goldman Sachs revived its moribund crypto trading desk and BNY Mellon, the nation's oldest bank, said it plans to open a digital assets unit later this year.

Elon Musk, the mercurial head of Tesla, has teamed up with Jack Dorsey, the head of the payment company Square, and MassMutual Insurance, among others, in putting some of his electric car company's corporate cash in crypto. He acquired a modest $1.5 billion in bitcoin and announced that he would accept the currency as a payment for his cars. Virgin Galactic now takes bitcoin for space travel.

Musk's investment is puny compared to that of MicroStrategy's, a business intelligence software company that over the last year has built up a $4.5 billion stake. CEO Michael Saylor says he began buying early last year because his investors expect him to earn a return that at the very least keeps pace with the rise in the S&P 500. He says keeping his company's reserve funds in cash, as the Fed flooded the market with new dollars, no longer seemed like an option.

"No one can stay in business holding a billion dollars of cash in a bank account yielding 15 basis points as the cost of everything you want to buy is going up 25 percent a year," Saylor told Newsweek. "That's an awful idea."

Digital Gold

Whether the changing attitudes are enough to ensure bitcoin and other cryptocurrencies are here to stay remains to be seen. Not everybody is convinced. Kenneth Rogoff, a Harvard economist, former chief economist for the International Monetary Fund, and expert on both financial crises and central bank independence, says the current unique economic situation, created by the pandemic slowdown, makes it difficult to extrapolate into the future.

"It's sort of hard to know what the meaning of anything is, when interest rates are this low," Rogoff says. "We'll know better when interest rates eventually start rising. Ultimately, for bitcoin to have a long-run value—and I emphasize long run—there needs to be a use that's not just one cryptocurrency trading for another, like swapping comic books or trading cards."

He's skeptical that such a justification exists under normal circumstances—at least one strong enough to outweigh the downsides. Bitcoin, he notes, is "cash on steroids"—easier to move than cash and just as untraceable—which is why Hezbollah and other shady organizations use it. He expects the debate over how much to regulate bitcoin and other cryptocurrencies to continue. For the normal consumer, bitcoin itself carries high transaction costs and is environmentally inefficient. "If bitcoin ever started getting used for more routine transactions," he says, "it's going to get regulated more heavily. Every central bank is looking at this."

Rogoff acknowledges that as more powerful and influential people buy into crypto as a store of value—a kind of "digital gold"—it becomes increasingly difficult for Western regulators to stamp it out altogether.

"These are very powerful, influential people, but, ultimately, it's just not in the public's interest to have transactions go in any way that's not easily traced," Rogoff says. "Supporters may be able to buy off some politicians in the short run, but everyone's looking at this, every treasury. I've had regulators tell me, 'Look, for the moment there's innovation coming out of this space; if we ever start seeing a lot of transactions in our country, we're going to crack down, but for the moment, we're proceeding cautiously.'"

Ultimately, he believes, governments around the globe are likely to ban retail establishments from using bitcoin and outlaw financial establishments from taking it. "Right now, the governments haven't stepped in to do anything about it," he says. "But they will." (As if on cue, just days after I interviewed Rogoff, Reuters quoted a senior Indian government official that the world's largest democracy was likely to become the first major economy to make holding cryptocurrency illegal.)

Rogoff's argument has been used to justify the new crypto reporting requirements proposed in the final days of the Trump Administration, which would require crypto exchanges to track what their customers do with crypto and where it goes. In an apparent effort to avoid pushback, Treasury Secretary Steven Mnuchin unveiled the initial proposal just before Christmas, under a 15-day truncated comment period. Industry lobbyists worked through the holidays, mustered more than 7,000 comments opposing the rules, and hired Paul Clement, a former Solicitor General and Washington, D.C. legal heavy hitter to represent them.

In the end, Treasury agreed to extend the comment period, allowing them to run into the Biden Administration. The Blockchain Association's Smith says she believes current Treasury officials are taking a "much more reasonable" approach to finding a solution to the problem of money laundering.

Smith argues that since banks are not required to track how customers spend cash after they withdraw it, it's unfair to require crypto exchanges to track cryptocurrency transactions. Whether they will ultimately win the argument remains to be seen.

Other former regulators and experts are less certain than Rogoff that tight regulation is inevitable. But they still warn that the current valuations of bitcoin may be unsustainable. One of those skeptics is Raghuram Rajan, a finance professor at University of Chicago Booth School of Business whose long resume includes stints as an IMF economist and the Governor of the Reserve Bank of India; in 2005, he was among the first to warn of growing risks to the U.S. financial system, which seemed prophetic when the subprime bubble popped a couple years later.

Rajan now says that bitcoin and other cryptocurrencies "are seen increasingly as an asset class which is valued simply because others value it. To that extent, it has some features of what economists call a bubble—something that is valuable only because everybody else thinks it's valuable. Which means that it has the potential for volatility. As people become less enthusiastic about it, its value could fall considerably." Bitcon's volatility is legendary. For instance, although the overall trend since its low in 2019 has been up, bitcoin's value between then and the current rise last fall has whipsawed. Nobody is responsible for maintaining its value, as a central bank would with a traditional currency. Bitcoin, says Rajan, does not have "intrinsic fundamental value as you might have in say, gold."

Dance Party

Novogratz, ever the salesman, insists there's no turning back.

Bitcoin is not so much a currency as a social movement, he says—one that has now collected a critical mass of adherents. When I ask him to elaborate, he refers me to a video, "How to Start a Movement," by entrepreneur Derek Sivers. A shirtless man in shorts is dancing joyously, alone, on a grassy hillside, surrounded by picnickers sitting on blankets. He looks ridiculous. But soon a second dancer arrives and awkwardly joins in, followed by three more, and then another three more. In the end, almost everyone is dancing—and then who looks ridiculous? The few who remain on the sidelines.

The big players in corporate America and on Wall Street hate to be the first on the dance floor, but "now everybody is joining the dance," says Novogratz, which explains bitcoin's "accelerating adoption curve." His firm, Galaxy, has benefited greatly—with $1.2 billion in assets under management, its earnings in the 4th quarter of 2020 increased by 650 percent. Meanwhile its stock price had risen from a low of 52 cents to more than $15 when last week, Morgan Stanley, which manages more than $4 trillion, announced plans to allow their financial advisors to buy bitcoin on behalf of clients through Galaxy's investment funds. That announcement sent Galaxy's stock surging north of $20 a share—an increase of more than 30 percent in two days.

"The most important thing that's happened in the whole bitcoin ecosystem happened in the last two months," he says. "Because in the last two months, everybody in both the tech world and the finance world has said, 'this is here to stay.' It's no longer a debate. It's over. The debate ended. Crypto is now an asset class. Critical mass has arrived. We're over the hill, and we're rolling downhill fast."

When pressed, however, Novogratz acknowledges that there is no way to know whether the "social construct" propping up bitcoin will collapse or not.

"We don't know that," he says.

He sees no sign it will happen anytime soon. But what if things should change? What if the smart money starts to run for the exits and Novogratz finds himself once again among a mob of Paris Hilton fans? He can always do what he did the last time: Sell for a tidy profit.

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