More and more investors speculate about Bitcoin. Interest in the best-known cryptocurrency is also growing among major investors such as pension funds. But what actually happens behind the scenes?
For the most important cryptocurrency, 2021 is already an extremely turbulent year. In early January, Bitcoin – invented in 2009 – reached a new record high of more than $41,000. Since then, the digital currency, which was originally intended as a means of payment, has temporarily lost a lot of value again – with price losses of up to 20 percent within a few hours. Finally, it went back in the other direction. For example, a simple tweet by Tesla CEO Elon Musk and discussions by private investors in Internet forums were enough to drive the price up by 20 percent at the end of last week. This rollercoaster ride repeatedly brings the largest digital currency into the headlines with a market share of over 60 percent. Industry experts have been reporting a growing interest in Bitcoin for some time: In addition to private individuals, large institutional investors such as banks, insurance groups or fund companies are now also entering the market.
First “crypto fund” in Germany
Patrick Karb, Managing Director of Frankfurt-based Hauck & Aufhäuser Innovative Capital GmbH, also notes this. “We see great demand from investors, especially on the institutional side,” he says in an interview with tagesschau.de. For this reason, the private bank Hauck & Aufhäuser founded the subsidiary in September and launched the first fund in the German financial industry at the beginning of the year, which consists exclusively of digital assets such as Bitcoin. The bank is cooperating with the Berlin fintech Kapilendo, which takes on the role of crypto custodian – i.e. the one who manages and secures the extensive calculation codes that make up the e-currency.
The demand from customers, from small semi-professional investors to pension funds, pension funds, and other investment funds to MDAX corporations, is enormous. This is also due to the recent development of Bitcoin. “The topic was also widely disseminated in the media so that cryptocurrencies became more popular not only in the private but also in the institutional sector,” says Karb. Especially in the Corona crisis, alternatives are being sought – Bitcoin also serves as a refuge currency, so to speak
Predominantly men invest in Bitcoin
Currently, the proportion of institutional investors worldwide is still very low. “Of the current about 700 billion US dollars in Bitcoin, about one percent is institutional money,” Jeff Currie, head of commodities at the US bank Goldman Sachs, recently told CNBC. The majority is traded by private individuals. Among these crypto investors, according to a recent study of around 100,000 investor profiles of a large German online bank, 90 percent are men. Other typical features are a comparatively high income and a certain affinity for technology, scientists from the Frankfurt Leibniz Institute for Financial Market Research found in the study. But how does this trade actually work
Hardly any regulation
“Before we trade, we monitor the prices on the platforms Coinmarketcap or Bitstamp, for example,” explains fund manager Karb. The opening and closing of the foreign traditional stock exchanges are also relevant at the time of purchase. “We are already seeing a correlation between the crypto market and the traditional market. In many cases, the overall economic situation also affects Bitcoin,” says the banker. For example, he has also benefited from the dispute over the speculation of the Gamestop share. Especially on weekends, however, there are often less fluctuating prices. The laws of Bitcoin development are complicated overall and not always rational.
The bank does not trade directly via special crypto exchanges and platforms, because these would for the most part not have sufficient admission in Germany, explains Karb. “We wanted to avoid getting the bitcoins from sources that we can’t uniquely identify.” On the blockchain, the technology behind Bitcoin, and a kind of digital logbook, the sources of origin are unknown.
That is why Hauck & Aufhäuser acted as a broker to the Frankfurt Bankhaus Scheich, which also has an approved crypto custodian. This at least reduces the risk of money laundering, says Karb. “When we order a transaction, Kapilendo verifies it, approves it, and transmits the order. Bankhaus Scheich then stocks up on the crypto market via various exchangeswithCoinbase or Kraken and makes the Bitcoins available to us in the fund’s wallet.”
Banks can act as brokers
The software for Bankhaus Scheich or Münchener Bankhaus von der Heydt, which plans to launch a crypto trading platform for institutional investors at the end of the first quarter, is being developed by the Frankfurt-based company Blocksize Capital. It ensures that the banks can act as brokers. The technology bundles the liquidity of 50 crypto exchanges, as Managing Director Christian Labetzsch reports. Within 100 milliseconds, the best possible price is recognized and the transaction is implemented immediately.
Normally, unlike the stock market, there is no middleman in crypto trading like a bank or a broker, Leon Berghoff, a graduate of the Frankfurt School of Finance & Management, explains to tagesschau.de. Exceptions in Germany are the Stuttgart Stock Exchange with the BISON app and the BSDEX (Börse Stuttgart Digital Exchange) or the Berlin crypto bank Bitwala.In most cases, however, investors set up an account directly with the stock exchange, which has both advantages and disadvantages. “Trading is much more transparent at first: You can use the trading data to see exactly what is happening on the crypto exchange,” says Berghoff. Another advantage lies in the relatively low transaction costs.
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One risk, on the other hand, is custody. In regular trading, the cryptocurrency must also be stored on the stock exchange. “It can happen that stock exchanges are at the mercy of hacker attacks and the money disappears,” warns Berghoff. However, the more well-known exchanges are now more professional and better protected. The lack of regulation and state security can also become a problem for private investors.
How does a Bitcoin get to the buyer?
Leon Berghoff is a so-called quantitative trader at the startup Sixtant – and thus partly responsible for the fact that investors can buy Bitcoins at all. The company is a global high-frequency trader in the crypto sector. As a rule, such traders have contracts with crypto exchanges such as FTX, Binance, Bitstamp, or Bitso and ensure that there are always enough Bitcoins there. In return, they receive a fee.”If an investor wants to buy or sell a cryptocurrency, we are ready to be the counterparty to that trade at any time,” Berghoff explains. Since these transactions take place very often, high-frequency traders execute several trades per second. This is intended to keep the difference between the purchase and sale price low. Sixtant either borrows the coins from the respective exchange or buys them on the open market.
So that these companies, known in the financial world as “market makers”, are subsequently not exposed to the price risk due to the extreme fluctuations of Bitcoin, they also hedge against price losses within milliseconds. “We are always on the wrong side of the trade,” says Berghoff. If the market goes up, he has to sell Bitcoin – the opposite of successful investing. “When we buy bitcoins from someone, we try to sell the currency again as quickly as possible or buy a derivative with which we shorten the bitcoin.” By relying on falling prices as a counter-transaction, the risk is minimized.
Predictions by algorithms
In addition, many companies in the scene also have a department that makes profits through its own trading on the free market. The aim is to predict certain developments of Bitcoin minutes or seconds in advance, as Berghoff explains. In quantitative trading, this works automatically. As a dealer, he is employed around the clock. “Unlike a stock trader, a day as a crypto trader goes 24 hours, as the crypto exchanges are open at all times – 365 days a year,” says the expert. A lot can also happen overnight because cryptocurrencies fluctuate greatly. “This means that I first check the system and see how the algorithms acted and whether there were any technical problems,” says Berghoff. The Sixtant employees are spread all over the world to examine the system and the markets at all times.
“More screens than I would admit”
Otherwise, algorithmic trading has a lot to do with programming codes. “We get historical data for individual cryptocurrencies on certain exchanges: For example, I look at the price data of Bitcoin per minute over the past three years and try to find anomalies in it,” explains Berghoff. On this basis, he finally developed an algorithm that takes this effect into account in trading: “If it has worked in the past, we hope that it will also work in real-time.”Comparable, for example, is the so-called “Monday effect” from stock trading.
This states that Monday is traditionally the weakest day of the week on the stock market. In crypto trading, however, this is much more complex, according to Berghoff. By exploiting anomalies, attempts are made to make profits in proprietary trading. In addition, a high-frequency trader must check the codes and technical relationships on a trader’s day and correct possible errors. But he has, says Berghoff, “more screens at my workplace than I would admit.”
