Oh the shorts! Those terrible, carpet-bagging speculators who destroy investor’s dreams.
The history of finance is filled with instances where this dangerous game of ‘the short sell’ goes to far, and something has to be done to curb it.
Daniel Troota of Thomson Reuters gives us the first example:
In 1609, a merchant contracted to sell shares in the Dutch East India Company in the future, sending the company’s share price into a plunge. A year later, the authorities imposed the world’s first ban on short selling.
Mr. Troota is writing about the SEC’s efforts to impose a ban on short selling during the 2008 financial crises, but he gives more examples:
Short sellers, or “shorts,” have been blamed for almost every financial crisis in the 400 years since the Dutch episode. Shorts came under fire after the U.S. stock market crash of 1929, and U.S. President Herbert Hoover condemned short selling in 1932. More recently, shorts were blamed for the U.S. stock market crash of October 1987 and, in 1997, Malaysia charged Credit Lyonnais with short selling after the collapse of the country’s currency and stock market. The next year, the New York Fed bailed out Long-Term Capital Management to avoid wider market impact from the hedge fund’s short positions.
However, one recent example comes from the Chinese market as reported on Bloomberg:
The Ministry of Public Security said it will help the China Securities Regulatory Commission investigate evidence of “malicious” short selling of stocks and indexes, according to a statement on its website Thursday. Vice Public Security Minister Meng Qingfeng visited the regulator’s offices in Beijing on Thursday, the official Xinhua News Agency said earlier on its microblog.
Oh yes, the term “malicious” raises its ugly head. What is meant here? Only that the Chinese Government suspects a deliberate coordinated attempt to disrupt their financial markets.
Malicious short selling is very real and the most recent examples can be found in the cryptocurrency markets. I am speaking, of course, about the recent attacks on both Ethereum and Bitcoin. In both cases, suspicious short selling occurred quite prior to the hacks. While I would never go so far as to condemn short selling wholesale, I would like the reader to take notice that ‘malicious’ short raids are happening in cryptocurrency.
The day after the Ethereum hack
the Author made a rather prophetic video on youtube about what could be expected next. This is while many Bitcoiners expressed joy at the Ethereum/Dao debacle. “If you think something like this can’t happen to bitcoin, then you are naive,” the Author said. It gave the Author no happiness to see the hack on Bitfinex. He would have preferred that someone had listened to him instead, and done something to prevent it.
In both cases, the question over what would happen to the hacked funds was front and center in everyone’s mind and caused a panic in both cryptocurrencies. This was exactly what the hacker wanted, of course. However, the funds could have ended up worthless if the hack was fully successful, so spending the stolen funds could not have been the hacker’s priority. The hacker must have been interested mostly in the shorts, since every effort to move the funds leaves a trail of evidence, fully ledgered on the blockchains of both networks. So while there have been some attempts at moving the funds, such efforts seem minimal and only with the intention of further disruption. Clearly, in the hacker’s mind, the less done with the funds the better.
It has been said that the survivors of abuse can end up abusers themselves. Unfortunately, we have seen some victims of the Ethereum/Dao hack doing just that, abusing other investors with malicious short sells and deliberate dumping to crash price. I won’t bother to go into the details. It is well documented elsewhere and the abuse may be coming from both sides. This is not the first cryptocurrency war and will likely not be the last. However, if the currency wars that have happened in legacy markets are any indication, the war will not go well for either party.
One conclusion from all this, is that the Ethereum hard fork was totally unnecessary. If the cryptocurrency industry had worked together and planned for such assaults, the problem could have been managed much better. I fully expect this cooperation will occur in the near future. For now, the industry is mired in turf wars, playing out a version of the movie Highlander- ‘there can only be one!’
I remain optimistic in systems that deploy what Nick Szabo, a prominent smart contract analyst calls a “Nakamoto consensus”, or what other’s incorrectly define as blockchain technology. As you may recall from my last article, I wrote about how Bitcoin specifically is building trust as part of its network effect. Let’s look at something Szabo said:
Trust-minimized code means you can trust the code without trusting the owners of any particular remote computer. A smart phone user in Albania can use the block chain to interact with a computer controlled by somebody in Zimbabwe, and they don’t have to know or trust each other in any way, nor do they need to depend on the institutions of either’s countries, for the underlying block chain computer to run its code securely and reliably. Regardless of where any of the computers or their owners are, the block chain computer they share will execute as reliably and securely as consensus technology allows, up to the aforementioned limits. This is an extremely high level of reliability, and a very high level of security, compared to web server technology.
Interesting to say the least, but lets look at another:
What kinds of fiduciary code can we run? We are still thinking up new applications and the categories will be in flux, but a very productive approach is to think of fiduciary applications by analogy to traditional legal code that governs traditional fiduciary institutions. Fiduciary code will often execute some of the functions traditionally thought of as the role of commercial law or security, but with software that securely and reliably spans the global regardless of traditional jurisdiction.
Good actors in the space will soon realize that the industry needs standards to deal with the sort of nonsense we saw with Ethereum and Bitfinex. The thing about a “Nakamoto Consensus” is that it records everything that has ever been done with every coin on the network. Eventually the wallets of bad actors become well known. We have seen this be of service already in both hacks and this will only improve in the future.
A block-chain computer, in sharp contrast to a web server, is shared across many such traditional computers controlled by dozens to thousands of people. By its very design each computer checks each other’s work, and thus a block chain computer reliably and securely executes our instructions up to the security limits of block chain technology, which is known formally as anonymous and probabilistic Byzantine consensus (sometimes also called Nakamoto consensus).
I place high importance on this Nakamoto consensus Szabo speaks of. With it, we may be able to resolve the malicious shorting that has plagued us since 1609, but that is just the start. I see so much more coming our way and I plan to tell you about it.
Disclaimer: The Author owns Bitcoin and Ethereum Classic in his portfolio. Nothing the Author writes should be considered financial advice.