Photographer: Andrey Rudakov/Bloomberg

Bitcoin Traders Claim There’s Method to Their Madness

They’re not exactly trading on economic or technical analysis.

Tracking the daily moves of the cryptocurrency craze can be exhausting. For now, Friday looks like the reckoning, with bitcoin prices plummeting. But just a day earlier, investors were sending the stock of a company up as much as 289 percent after it changed its name from Long Island Iced Tea Corp. to Long Blockchain. The day before that,the news was dominated by insinuations of insider trading on a prominent exchange. And who can even remember Tuesday at this point?

“It’s one of the most inefficient markets I’ve ever seen,” said Arjun Balaji an engineer who trades cryptocurrencies and surveyed the dot-com bubble from his vantage point in kindergarten. Balaji has been buying bitcoins since 2012, and has recently made hundreds of thousands of dollars by day trading other digital coins, too.  The market for cryptocurrencies is almost universally referred to as a bubble at this point, but it’s probably more accurate to describe it as a series of bubbles that are closely—but not entirely—related. In recent months, jumping between these bubbles has proven particularly profitable, leading to a cottage industry of self-proclaimed experts. “The money is moving from people who don’t understand the market,” said Balaji, “to people who do.”

Movements in the market for cryptocurrencies don’t reflect the outcome of rigorous economic or technical analysis, or even a basic theory of why the blockchain technology underlying these currencies even matters. “This is a manifestation of unmet demand for honest speculation,” said William Goetzmann, a professor at Yale University who studies the history of financial bubbles. “Those are legitimate needs that people have, to figure out if there’s a way to gamble their way to another lifestyle.”  

Balaji claims not to be in it for the money, although his Twitter bio does mention a fondness for watches. He got interested in bitcoin in college because he liked the idea of a form of money that couldn’t be manipulated by governments. But that conviction has little to do with how he now makes money trading. Earlier this week, he showed up at a coffee shop near Union Square in Manhattan to explain his tactics. Thin and baby-faced, Balaji was wearing a light hoodie and ordered iced coffee, even though the temperature was hovering around freezing. Flipping digital coins is akin to a game, he said, and many people are playing with only a thin grasp of the rules.

Balaji trades almost entirely on how he thinks other people will act in the very near term. He tries to anticipate the market by monitoring the movements of a handful of sophisticated players with huge holdings, while also gaming out the psychology of others who have no idea what they’re doing. Another trader, who asked not to be named because he didn’t want to attract negative attention, boiled his trading strategy down to coming up with the most superficial understanding he can imagine, then assuming that’s how the market will act.

On Nov. 17, Balaji made a significant bet that many newcomers didn’t realize they can buy just part of a bitcoin. He assumed new investors would set up an account on the popular exchange Coinbase hoping to buy bitcoins, balk at the price, then settle for a cheaper alternative. So Balaji bought litecoin, which was the lowest-price cryptocurrency trading on Coinbase at the time. When he bought his stash, the price of a single litecoin was $67, compared with about $8,000 for bitcoin.

Balaji’s hunch paid off. The number of new Coinbase users shot up around Thanksgiving, and the price of litecoin spiked, too. Balaji doesn’t think much of litecoin, deriding it as nothing more than “a copycat of bitcoin.” But supporting litecoin was never the point of his trade. He sold his holdings on Dec. 12 when litecoin was worth $387, a 570 percent gain that was far higher than bitcoin’s appreciation over the same period. He was vague about the exact profit, but said it was in the six figures. Litecoin declined in price soon afterwards.

Because Coinbase has become the on-ramp for the least-informed investors, demand for a coin can spike solely because the exchange lists it. That means investors trade on guesses about when Coinbase will list a particular cyptocurrency, like one called bitcoin cash, which was the subject of alleged insider trading this week. Balaji, for example, spent a few days riding rumors that Coinbase would list another coin called ripple, before dumping what he’d bought for twice what he paid after a few days.

The young industry is curious to see how newcomers like Goldman Sachs Group Inc. adapt to this market. Much of today’s research consists of monitoring the mood of a coin on Twitter. Nelson Merchan, a recent college graduate who trades cryptocurrencies full-time and runs the popular Twitter account Crypta de’ Medici, said each token has backers and detractors. He feels things out by tweeting positively or negatively about potential investments to see how people react. This can be tricky, he acknowledged, because unscrupulous traders use Twitter accounts to drive up interest in coins its operators own. The tiny market for many coins makes them vulnerable to this kind of market manipulation.

Most people like Balaji think they’re smart enough to buy into a bubble on the way up and sell before the crash. But many aren’t. In a major price correction, they risk losing much of what they put in. Nor is it entirely possible to tell who the smart money is at this point. Given that the market is in ascent, it’s been easy to profit.

After an hour of talking about tactics for riding the herd mentality into short-term profits, Balaji veered into politics. He describes himself as a libertarian, although maybe not as pure of one as he used to be, and recommended The Sovereign Individual, a 1997 book that anticipated bitcoin-esque cybercurrencies that would allow people to liberate themselves from the power of government.

The political digression reflects a quirk of bitcoin culture. Many people who got in early enough to count as sophisticates did so for ideological reasons; their transformation into day traders is a bit accidental. Balaji trades because he wants to place an all-in bet on a digital currency that many people still think could be worthless by his 30th birthday. “The only reason I trade alt coins,” he said, “is to get more money to put into bitcoin.” When the price dropped late Thursday and Friday, he didn’t have to think much about what to do. He bought more.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE