Can the bitcoin market absorb hundreds of millions in institutional capital? We’re about to find out

By Michael Carney , written on March 25, 2014

From The News Desk

On an average day, the bitcoin market sees a few hundred million dollars in worldwide trading activity. Over the last 24 hours, that activity took the form of 67,054 transactions recorded in the Bitcoin blockchain, in which 630,633.08 BTC changed hands. Next to Wall Street, where the NYSE alone trades 1.4 billion shares and $58 billion in value daily, these numbers pale in comparison.

This gap, however, looks poised to narrow considerably. The bitcoin market is about to get slammed with more capital and more trading sophistication than it’s ever faced. Anyone who tells you they know what the impact of this inflow will be is smoking their own supply.

SecondMarket founder and CEO Barry Silbert tweeted Sunday:

Silbert’s tweet was presumably in reference to his forthcoming institutional bitcoin exchange, but may also indicate interest in his firm’s $55 million and growing Bitcoin Investment Trust (BIT). It would only take a small fraction of that $250 billion in capital to dramatically alter the bitcoin trading landscape.

SecondMarket isn’t the only group bringing sophisticated investors into the bitcoin fold. Silbert’s suggestive tweet comes on the heels of Pantera Capital announcing the first close of $150 million in institutional capital – initial backers include Fortress Investment Group, Benchmark, and Ribbit Capital – for its Pantera Bitcoin fund earmarked for bitcoin trading.

It’s not just institutional money that is eyeing the bitcoin markets either. Both SecondMarket and the Winklevoss brothers are in the process of creating regulated, and publicly traded bitcoin funds that, once available, should dramatically simplify the process of retail investors accessing the bitcoin markets, while also adding a measure of transparency and sophistication to the process.

In other words, bitcoin is about to go from a niche, hobbyist market to a mainstream one frequented by professionals. All told, the amount of capital flowing through the global bitcoin markets seems likely to grow many times over.

Bitcoin bulls like to cite the “market cap” of the entire bitcoin system, which is currently around $7 billion. Ignoring the fact that market cap is the wrong term for this figure – ecosystem value or something to that effect would be more appropriate – these discussions regularly fail to acknowledge that only a fraction of this sum was ever invested into bitcoins.

There's only a few thousand coins available for sale on the world’s exchanges any particular moment. The price, and thus the “market cap” of the system is predicated on this relatively small sample. The bulk of bitcoins were mined or purchased at very little cost, and a large percentage have never changed hands since, despite appreciating in value hundreds or thousands of times over in the years since. The big question is, how will a dramatic increase in capital in the system change this behavior.

Bitcoin has been in a relatively stable period for the last month, fluctuating between $550 and $650, and moving only single digit percentages on most days. This is after a year in which bitcoin raced from approximately $15 up to an all-time high of over $1,200, rising and falling by upwards of 100 percent on many days, often on the back of emotional news coverage around events like regulatory changes, exchange hacks, and Wall Street research reports.

A capital inflow of a few hundred million dollars, should it occur, would dramatically alter the bitcoin landscape. The first and most obvious impact is likely to be a significant uptick in price. Economics 101 suggests that an increase in demand without commensurate increases in supply should increase the price of any good. The rate of bitcoin creation is fixed, so the only variable is the number of people willing to sell their bitcoin holdings – and at what price.

But it’s far from certain that this uptick in price will be a good thing or that the systems in place across the bitcoin ecosystem are prepared for this level of activity and the scrutiny that’s sure to follow. Silbert and his ilk have acknowledged this fact and are working feverishly to build the next-generation of bitcoin platforms to ensure that the Mt. Gox situation doesn’t repeat itself. But with anything this new, the only certainty is often uncertainty.

Less clear is the impact that Wall Street involvement will have on the stability of the bitcoin market. The irrationality and emotional nature of Mr. Market is well documented, so it’s tough to predict that bitcoin will stabilize overnight. But more capital, and more trading activity, should eventually increase liquidity and help bitcoin find a more predictable trading range. Finally, Wall Street’s tacit endorsement of bitcoin should add an air of credibility as regulators decide how to govern this emerging new financial landscape.

It’s been a rocky four-plus years for bitcoin since its inception. But with the world’s eyes now fixed squarely on the crypto-currency, it appears bitcoin is being called up to the big leagues, and quick. The questions is, can this proverbial 19-year-old withstand the glaring lights of starting in the World Series?

[Image via Fdecomite]