Short Selling Explained, Tesla and How Controversial Shorts Work, and Nvidia and Bitmain
Here’s a transcript of QuantLayer Crypto Podcast #8.
On this episode Faizaan and I take a deep dive into shorting; what it is, how it works, why it works, why people short, what the psychology of shorters is, and when shorting can go horribly wrong. We also talk about the bull and bear case around Tesla ($TSLA) and how that’s tied to controversy and short selling. We take a deep dive on Nvidia, its IPO, and the company’s gross margins and how that relates to the recent news of a potential Bitmain IPO filing. We also consider the current browser wars as they relate to Crypto and continue our discussion around some benefits of the Bitcoin 2nd Layer Lightning Network. We also cover some interesting alerts that came through our platform in the last week.
The episode in its entirety can be listened to here:
QuantLayer is a software consultancy based in Brooklyn, New York. All opinions expressed by podcast guests are solely their own opinions and do not reflect the opinions of QuantLayer. The information presented should not be construed as investment advice. Guests may maintain positions and assets mentioned in the podcast.
Vikram: Hey everyone. You have QuantLayer here, Vikram speaking. I’m joined by Faizaan a.k.a the Wizard. Hey, Faizaan, how’s it going?
Faizaan: Good. How’s it going?
Vikram: It’s good. We’re both in New York this time. That’s a pretty big change. It has been a ton of travel the summer for both of us.
Faizaan: Yeah. Yeah. I’ve been in Toronto quite a bit and then I was recently in Medina, Colombia. I just got back from there and now finally back in Brooklyn for a little while.
Vikram: Nice.
Faizaan: Are you?
Vikram: Yeah, I was in New Mexico. Portland. I think I was in DC at one point too, but I don’t have any travel plans coming up, so I’m glad to be back in New York, at least for a little while.
Faizaan: Nice.
Vikram: There has been a ton of articles on short selling recently, and I think one of the reasons they’ve popped up a lot; and this happens in traditional media, traditional financial news media as well; is when a stock is at all-time highs, people will start reporting on how to buy it, when something’s at all-time lows, people will start reporting on how to short it. So, in the last week I saw a ton of articles on ‘why can’t we short Bitcoin’, ‘how to short Bitcoin’; things like that. So, I just wanted to talk a little bit about the mechanics around shorting; because if you’re outside of the investment community, it’s either black magic or people think it’s evil, and its evil because you’re betting against a company.
Faizaan: Right.
Vikram: But the fact of the matter is, you know, companies fail; assets go down, markets change. We can only have functioning markets when we have instruments that allow us to manage risk and manage how companies and markets fail. So, I thought it would just be useful to talk a little bit about what shorting is and how it works because it is really opaque. There are articles out there, but I still don’t think they’re super clear. Anyway. So, how does shorting work?
So, for those who aren’t super familiar with the term, it’s often thought about as a way for people to bet that an asset’s price is going to go down. How does that work? It works through borrowing and we’ll talk about that a little bit, but let’s first talk about just what even being long means. If you own something, you are long that thing. So, if you have long position, you own a particular asset. Say, you’re bullish on Microsoft and you want to own a hundred shares of Microsoft stock. You go to an exchange and say I want a hundred shares of Microsoft at a certain price — Microsoft right now is trading at $100 — so you say, ‘okay, I want a hundred shares of Microsoft at $100’ — and we’re just doing round numbers here because it’s easy to talk about.
So, you put in your order and it gets accepted and congrats, you’re now the proud owner of a hundred shares of America’s first operating system company. Now what? There’s not much you can do at this point. You’re going to receive a small dividend, right now at $100; that comes out to about $40 per quarter based on your holdings; but other than that, you can’t do much more. You’re just betting on price appreciation and continued success of Microsoft, but wait, what if you actually could do something more with your holding of Microsoft?
So, this is where shorting comes in, and it’s going to get a little weird, but I think if we just talk through it, it’s a pretty simple mechanism. It’s just not explained super well. Now, say you own a hundred shares of Microsoft and say you have a neighbor that hates Microsoft. Maybe Windows 95 ate their homework and they failed their final English paper and had to be held back a grade or maybe they think Microsoft doesn’t stand a chance against Open Source. Who knows? They can have any reason to be negative on Microsoft, but how can they actually take a bet that the stock is overvalued or is going to go down?
They can short. Here’s the actual mechanism of how shorting works. So, you own a hundred shares of Microsoft. Your neighbor wants to short 50 shares of Microsoft, so you decide you want to lend them 50 of your 100 shares. You’re not just going to lend it to them for free. You’re going to put an interest rate, borrow rate. So, let’s just say, it’s 10%. That’s really high, but it’s just easy to do mental math with it. So, you’re going to lend them 50 of your 100 shares at 10%, and that means they have to pay you to borrow your shares. This is the part that sounds really weird. Like, what does it mean to borrow shares from someone else? It just means what it sounds like. You own some shares; you’re lending it to someone at an interest rate, like any other borrowing and lending mechanism. There’s just nothing to really see because there’s no physical stock to be delivered, but just imagine it that way.
You’re going to borrow 50 shares from someone, I’m sorry, you’re going to lend 50 shares to someone and you’re going to get paid some interest on it. So, now what happens? Your Microsoft-hating neighbor shorts 50 shares of Microsoft. Say that over the next few months Microsoft goes down to $80. Your neighbor is now in the green. They’re profitable by a thousand dollars. So, that’s $20 of profit times 50 shares; because they had shorted it at $100 and now it’s $80.
Faizaan: So how do they realize this profit?
Vikram: Okay. So, say, they have appeased their hatred of Microsoft and they decide to close out the position. This means that they cover their position and they deliver their shares back to you. So, what does that mean? They borrowed a hundred shares from you. At some point they have to give it back, right? So, the only way they can give it back is by actually covering what they borrowed and then delivering those shares back. What that gives them is they capture that thousand dollars and then now they can make fun of you at the next neighborhood barbecue.
Faizaan: Now you aren’t at a loss because you haven’t sold your position. In fact, you might be in the red, but you’ve managed to generate some income by the lending process. So, in fact that the stock can even recover and in the event that you’re still in, you’ll benefit from that.
Vikram: But what happens if Microsoft doesn’t go down? Okay. So, this is where it gets pretty interesting. Say, over the next few months, Microsoft goes to a 120. That means your neighbor is now down a thousand dollars on the position plus any interest that they paid to you. If they decide to close the position, they have to purchase 50 shares of Microsoft at 120 in order to deliver the shares back to you since you are the one who owns them, and they would be down a thousand dollars less the interest.
Faizaan: So, in the real world, the situation that I presented is not like this. This isn’t actually how it happens. In the real world, all this stuff happens through exchanges and the real lenders themselves are the exchangers who profit from the borrow rates rather than you directly. There are probably some ways to lend on an OTC or over-the-counter basis, but, typically, that’s not how you short something these days. It’s actually pretty easy for most things, like you can use Ameritrade or whatever; you have to get approved [Inaudible] [08:18] to short, but as long as they have borrow available, you can just say, ‘Oh, I want to short Microsoft’, put the amount you want to short, click submit, and then you’re good.
So, what happens if someone is down on a short, like your neighbor who’s down a little bit? Say, you guys had agreed ahead of time, like ‘Okay. If you’re down more than $2,000 then you have to close it out’. Like that’s just part of the deal. Banks and exchanges have that kind of mechanism in place as well; where they can margin call you. You’ve probably heard the term before: margin call?
Faizaan: Yes. There was a movie that came out recently I think called ‘margin call’. It’s a very dramatic term in media.
Vikram: Basically, it’s just saying ‘Hey, you need this much of capital in your account to prove you can cover your short, and if you hit your margin call then that’s it. We’re going to stop you out. You’re done’.
Faizaan: So, just to reiterate so I understand correctly. You have a hundred shares of Microsoft, I borrow those 50 of those shares from you, I sell them and then the price of Microsoft goes up and I still owe you those 50 shares; which now instead of costing me $5,000 is going to cost me $6,000. So, I’m down a thousand dollars, and if you see that my account only has, let’s say, $1,500 and it’s not allowed to go below a thousand, that would be a situation where there’s a margin call.
Vikram: Right. Right.
Faizaan: Okay.
Vikram: Some exchanges and banks can say, ‘Hey, if you’re 10% we’re going to warn you, if you’re like 20 percent within your margin call or 10% within’. They’re going to do that. They can taper your account too. So, if you have a $100,000 in your account they can say, ‘Hey, you can only trade like 10% of that now because you’re so close’. Stuff like that. But yes, what you just presented is exactly how it works. It just happens through exchanges now.
Faizaan: Then if you’re long it makes sense for you. I mean, I know we mentioned that the exchange is the one that captures the profit, for them the lending, but in the two-party situations, if I was long I would capture the upside of the growth in the stock because I get my stock back plus the lending rate.
Vikram: That’s right. So, we talked a little bit about the mechanics in terms of stocks and it’s similar and probably even more dramatic in Crypto. The key thing to get out of all the mechanic stuff is that if you’re shorting something, some other party is lending you the short at a borrow rate. At some point you’re going to have to purchase the shares back to deliver them to the party. What your profit or loss is, is dependent on the stock price you repurchase it at, less the borrow.
In Crypto it’s not easy to short Bitcoin, let alone most [Inaudible] [0:55]. I think I’ve only seen maybe three on an exchange basis; Bitcoin, Ethereum — maybe it was Bitcoin Cash — and potentially Ripple. I don’t think those were the ones I’ve seen before. Also, Bitmax and a couple of the other exchanges are the ones who offer the ability to short, but outside of those it’s not easy. In fact, there’s a Crypto SubReddit, I think, where people offer borrow rates for different Crypto. These are people who own like a ton, maybe not even a ton, of some Crypto that they’re willing to offer it at some ridiculous borrow rate. So, at these rates, they’re high; like they’re 30, 40, 50% sometimes; which reflects the volatility in the space, but at some point these borrow rates just make no sense to pay.
Faizaan: Yes. I just had one question. I have been hearing in the news, I think late last year, that the CME or the CVOE started offering Bitcoin futures. Is that related in some way or is that a completely separate thing?
Vikram: Yes. No, that’s definitely related. Those Bitcoin futures have a high borrow rate on them. I think I saw a number like 40% — don’t quote me on that — but I think that’s what I saw, and again, the number reflects the volatility and the controversy around the asset.
Faizaan: Okay.
Vikram: This is actually a pretty good lead into what I was going to mention. Just to give an example: take a highly controversial hotly contested stock like Tesla, where you have bulls arguing the stock is undervalued because the total market is way bigger than people think, and bears think the stock is overvalued because they haven’t actually delivered yet. Actually, Faizaan, you understand the car market way better than me. What are some of the reasons people are really bullish and bearish around Tesla?
Faizaan: Speaking not from the perspective of markets, but just someone that likes technology; one, I think Model 3’s delivery rates are not very withstanding. I think a lot of people are just very bullish on Elon Musk himself because, with SpaceX and Tesla up until the Model 3, he’s proven that he can bring stuff to market that no one else has been able to do; something that’s a fundamentally better product. So, I think a lot of people just get excited about that.
From the car perspective, there are a lot of fundamental reasons why electric cars are better; if you think that, ‘Okay, Tesla is going to be one of the big players in this market’. Electric cars are fundamentally better for a lot of reasons. One, because they don’t have internal combustion engines. There’s a whole bunch of moving parts that come with internal combustion engines because you essentially have to take an explosion and make the wheel spin. Then you have all this emissions, and a fueling infrastructure also, that makes these cars very complicated. You have to get oil changes, transmission oil changes; a lot of maintenance stuff. Most of that goes away with electric cars.
The other thing is, because you can lower the center of gravity and not have this huge block in the front of the car, you can make it safer from a crash test perspective. You can build the entire frame of the vehicle differently. It handles better and your build materials should be a lot lower because you’re putting a lot less stuff into the car. So, you know, there’s definitely a lot of opportunity for electric cars and I think a lot of people are bullish that Tesla’s going to be the one to capture those markets. A little bit of a track record of Elon Musk having delivered with SpaceX and the way he got Tesla off the ground by, where you had the — what was it? — Tesla Roadster; which was really just a lotus with Tesla batteries and motors; low volume, high price car; then they went to something that was a premium priced but higher volume car, and now the Model 3, whereas most other electric car-makers tried to do like a $30,000 budget car. That was very unappealing.
Vikram: Yes.
Faizaan: As far as bearish, I think the three big ones are, especially in recent times Elon Musk has been really sort of personally volatile on twitter and just all this stuff he’s up to. A lot of people see he’s selling flame throwers on twitter or a lot of the recent commentary he has made with the Thai cave rescue and I think a lot of investors don’t like the idea of giving a guy like that billions of dollars.
Vikram: Yes.
Faizaan: The second is, just that if you look at how many cars Tesla makes; the fact that they’re not profitable and what their stock is priced at, I think a lot of people get scared by those numbers. It’s like how well would they have to do to justify their price. The third is it’s very hard to make a car. You can’t just build a car factory and start churning out cars. Most car manufacturers have been around for a long time. The supply chains are multi-tiered from raw materials to your plastics to your sub-assemblies to your assemblies; and getting all of that in place is very time consuming, complicated and not the forte of someone, like Elon Musk, that’s really good at, you might say, product development. Manufacturing and supply chain is a whole different thing and so people are rightfully skeptical that he can get the Model 3 out in the right volumes and quality needed. So, I don’t know. That’s my two cents.
Vikram: Just out of curiosity, how much was the Roadster? How much was the next model and what’s the Model 3 supposed to get appraised to?
Faizaan: Okay, so the Roadster. I don’t remember the exact pricing off the top of my head, but I want to say around $130,000 to $140,000 for two-seat sports car. That was always going to be a sort of a third car in someone’s garage and it had a relatively limited range, so it was $130,000 as a toy car — very much a toy car. It’s quite a different bracket. The next thing that came out was the Tesla Model S; again, these are rough ranges; but somewhere between $75,000, $80,000 to about $140,000. Now that sort of puts it in the speeding range of your premium to high end luxury sedans; like your 5 series, 7 series, S class; but that’s a primary car, a daily driver. So, even though the upper end of the Model S was priced the same as the Roadster, it’s really in a totally different bracket; because spending $100,000 on your primary vehicle is a much, much bigger market than $130,000 on a toy car.
Vikram: Right.
Faizaan: That market is pretty much dominated by, you know, people buy for brand and for what the car can do, and it’s an emotional purchase more so than a purely ‘how much am I saving on gas?’. So, getting into that market was a good way to get down.
Then the Model 3; that number, that always gets thrown around as the anchor price, is $35,000. The reason for that is that, I think, the average price of a new car in the United States is around $32,000, $33,000, if I’m not mistaken. So, $35,000 really puts you in the range of average new car purchases and well within the sort of upper end of premium and very low end of your luxury car brands; like your 3 series of a BMW. So, that was the big deal that ‘Oh, this is going to be a high volume car, that’s priced much more affordably, that’ll be electric and nice’, but a lot of the flack they’re catching is they’re understandably launching their high margin, high priced vehicles first. So, the upper end of the Model 3 is closer to $80,000.
Vikram: Got it.
Faizaan: There have been a lot of the complaints; people were like, ‘Where’s the mass market $35,000 car?’
Vikram: Yes. I mean, the controversy around it is pretty fair and because of that we can’t say what the future is going to be like, but you’ll have bulls and bears war over this stock. If you get bored with Crypto twitter, go look at Tesla twitter.
Faizaan: It’s just Elon Musk. Just him, and people are responding; the people that are long and short, I mean even the people that are long. I forgot the name of the fund, but one of the very long-term sort of funds that has been long Tesla wrote an open letter asking Elon to just chill out, on twitter.
Vikram: Yes. So, if you’re bearish on Tesla and you want to short it, you’re going to have to pay pretty high borrow rates going back to what we were talking about before. I’m going to quote S3 partners. It’s a third party FinTech data analytics company. I’ll link to them in the show notes, but this is what they said around the Tesla short borrow rate. ‘In October; that’s October 2017; when borrow rates were below a one percent fee, the total financing costs of the Tesla Short was less than $200,000 a day. Today, with rates on the existing $40 million shorts at 3.69%, it is costing short sellers $1.2 million a day to finance their short Tesla positions. If short selling continues to increase and rates hit the 10% fee level, it will cost between $2 and $4 million a day to finance the entire Tesla’s short book.’
Faizaan: Oh, wow.
Vikram: Yes, 10% is a pretty high fee. I remember from back in my trading days, a pretty controversial stock, where the borrow rate 2–3%, was high, and 10% is very high. I think the worst I’ve ever seen is probably like 25 or 33%. Something like that.
Faizaan: I’m also a bit curious to see the $2–4 million day number. Tesla’s market cap is, give or take, $50, 55 billion.
Vikram: Yes.
Faizaan: So, we’re approaching like a 10th of a percent of their market cap in just daily shorting fees.
Vikram: Yes.
Faizaan: I wonder how that compares to other stocks because that seems high to me.
Vikram: Yes. That’s a good observation. The risk there is that because of a very high borrow rate (implies high short interest of course; that means there’s a lot of short shares that are short) when Tesla continues to go up, like it has, it just gets more expensive to fund those shorts which puts a lot of pressure on the shorts, and the shorts will end up having to cover which will drive the price even higher.
So, with highly controversial stocks like Tesla, as the stock prices go up and/or some major event is coming down the line, the borrow rate, interest rates go up and it just fuels the continual performance of the stock. Of course, when you’re right, the stock will get crushed and that’s a different conversation. We’ll just talk about that in a bit, but one other thing that came to mind was GBTC. It’s one of these Bitcoin trusts that trade on the stock exchange, so S3 looked into them as well. I’m going to read off a little piece from TheStreet article which sites S3. ‘But the cost to short Bitcoin hasn’t been cheap, S3 found. Stock borrow costs have averaged a 10.2% fee for the year, and “borrow rates are getting more expensive as borrow supply diminishes”, S3 said. Since GBTC is more of a retail-owned stock than an institutionally owned stock, new shorts are being charged at an 18.5% fee. “If short interest continues to climb, we should see new borrow rates hit the 50% fee level quickly”. The cost to short the GBTC fund could rise higher than 50% and possibly near 100% by the time the first futures contracts trade, S3 noted. Many analysts have asserted Bitcoin is headed for a pullback when futures open for trading.’ 50 to 100%.
Faizaan: We had talked about the mechanics at the beginning and throwing out some numbers of how much profit you would take given some scenarios. So, in this situation of this possible 100% fee, if I borrow a thousand dollars’ worth of GBTC from you to short it and the fee is a 100%, what is my game plan? If it goes to zero in the course of a year, I still only break even because I’ve had to pay you that much in interest. Am I missing something?
No, you’re totally right. The situations where there may be some reason to put it on is if there’s some arbitrage place.
Faizaan: Super short term play.
Vikram: Yes.
Faizaan: Or they’re super short. There’s 100% fee for the year, but I think it’s going to collapse in a month.
Vikram: Yes.
Faizaan: The Lakers might make some…
Vikram: In GBT there was a particular play. I think you could get long the underlying which is BTC and then short GBTC and there was some kind of spread you can make money on.
Faizaan: Okay.
Vikram: Or the flip side. Basically, there’ll be some short term arbitrage type of thing where it makes sense.
Faizaan: Yes. Because at those lending rates, you need to see very big movements very quickly, otherwise you’re just going to get wiped out on fees, let alone even if the price goes down.
Vikram: Yes, exactly. That’s something that fund managers have to manage and especially there are some funds that are short only and they spend a lot on just managing their shorts.
Faizaan: So, why is that? What is the motivation to be short only or to be a shorter versus just faking things that you’re confident?
Vikram: The mindset of shorting; there’s a definite specific psychology to it, and one reason is that it’s very satisfying. Maybe this depends on person to person. Maybe some people find more satisfaction in being right long. Other groups of people find satisfaction in being right short. I probably subscribe more to the latter and the reason is that there are certain stocks that you do a lot of research into and you find some information that the market broadly doesn’t understand or know about, and you can take satisfaction in that. You found that thing and you were able to profit on it by being short.
So, maybe some company is experiencing a ton of competition from a really small company. Let’s say, a really well-known company in the US is facing a ton of competition from a really small competitor in Germany, right? In order to find that out maybe you need to know German, maybe you need to have some connection to Germany. So, you have now unlocked a piece of information that the market broadly doesn’t know about, and discounts because they don’t have the extra edge that you have due to your closeness to the story.
Faizaan: A funny story about that; the smaller company competing with the big one; is, so, we were talking about Tesla and you know how they announced that they’re going to make these semi-trucks?
Vikram: Yes.
Faizaan: There’s another company that is doing electric semi-trucks, called Nikola that has sued Tesla for patent fraud, I think, for $2 billion.
Vikram: Really?
Faizaan: It was just funny. The funny thing is I had heard about these Nikola trucks before the Tesla trucks actually, so they had been working on this,-
Vikram: Yes.
Faizaan: -which is funny with the name and the same product and all that.
Vikram: That is pretty funny. So, that’s one reason. I guess you could do that on the long side as well; but when shorts work out, they work out really quickly. Like, a stock can be down 40, 60, 80% due to competitive concerns in a very short amount of time versus a long where maybe they get bought and that has the stock go up a ton overnight, but usually they take a little bit of time.
Faizaan: Yes. I mean even a very successful business will take longer to grow than it takes to collapse on.
Vikram: Exactly. Exactly. Another reason is you get to reveal fraud. There’s a term in trading called ‘the angry short’ and it’s very accurate because if you come across a company that is engaging in fraudulent behavior or some aspect of their business is fraudulent and you want to get short them, you want to be right because you want the company to just get destroyed because they’re engaging in fraud. I think that’s a very natural way to feel about a fraudulent company, right?
Faizaan: Yes.
Vikram: Like, Enron; the housing collapse of 2008. These are examples of financial fraud that shorters benefited from. Another less talked about benefit of shorting in psychology is that they bring real concerns about assets into the discussion. So, I can be able to short something because I think that there’s some unaddressed threat to a company in their threat model; but once that gets fixed, I’ll cover. This helps incentivize teams to fix issues, and if not fix issues then address and clarify them. I think there’s this tendency we eluded to earlier where people think shorting is just evil because you’re betting against companies. But you’re not shorting because you think the company is going to go bankrupt, right? You’re shorting them because there’s some aspect of them that just isn’t working for them right now, and maybe that makes them go bankrupt.
Faizaan: I mean, you could argue, that if you want the markets to be efficient, you need to be able to provide information on either side; like, buying indicates that there’s confidence and shorting indicates that there’s less confidence; and you need to be able to provide both signals.
Vikram: Yes, exactly.
Faizaan: That’s all it is.
Vikram: Yes. Those are the main reasons people short. The other thing to know is that there are multiple types of shorters. It’s not just people who expect an asset price to go down; that’s definitely a large part of the short selling market. The other group to consider is hedgers. Here are some examples. Say, you’re a gold miner or an oil driller or someone else who deals with commodities on a day to day way. One way they manage that is by putting short positions on these commodities. An airline will have a finance department that manages all its oil holdings with short positions; because airlines, for example, have to deal with fluctuating oil prices. Gold miners will want to hedge against gold price volatility. Same is the thing with oil drillers. They’re not betting the price is going to go down; they’re just hedging their risk.
Faizaan: Right.
Vikram: So, I imagine Bitcoin miners, at some point, will want to limit their volatility. I’m sure they want to limit their volatility now; especially the large scale institutional minors; but at really high borrow rates, it doesn’t make any sense. You’re not going to pay like 30%, 50% to hedge your position that only moves like 10%. Right?
Faizaan: Right.
Vikram: This will change over time as the industry matures and, I think, all this stuff will lead to lower volatility in the Crypto assets.
Faizaan: But right now, you know, it’s just pretty interesting to watch.
Vikram: Oh, yes. I guess one thing we didn’t really talk about is what are the downsides to shorting?
Faizaan: Being wrong, right? Outside of a margin call, there’s an infinite amount of money you can lose by being short.
Vikram: Right, because if you’re long you can only lose the total price of that stock, but if you’re a short you can lose the entire amount that it moves against you.
Faizaan: Right.
Vikram: So, if you bought a penny stock and it goes to a thousand dollars, you’re in really rough shape.
Faizaan: Yes.
Vikram: And just psychologically, as humans, it’s really hard to manage that risk unless you are very diligent about it. Like, you buy a thousand dollars or we buy $10,000 on Microsoft. If Microsoft goes to zero, like you said, you only lose that $10,000. If you’re short $10,000 Microsoft, you don’t know what your downside is; if it goes to $200, 300, 500.
Faizaan: That adage, ‘only invest what you can afford to lose’ doesn’t apply here on shorting.
Vikram: If you don’t know how much you could lose; yes.
Faizaan: Right.
Vikram: There are some pretty common shorting fails. If you short something, say you short a company and then that company gets bought. Well, there you go. Your short just blew up because the MNA usually happens at a premium rate. Also, it’s just being wrong. Like, if you were getting heavy into shorting banks in 2008 because you saw that Bear Stearns collapsed and you thought that was going to happen to everyone, you probably would’ve made some money in 2008, but in 2009 and 2010 when the market started recovering, you would not have.
Then there was this weird phenomenon where you could be correct, but because so many other people are short as well, you actually don’t profit. Say, people are short into a quarter because they think it’s going to be a really bad quarter. The quarter happens. Nothing else has really changed with the company. People just wanted to get short the quarter because they thought it was bad and then the stock isn’t down that much. It’s down 3 or 4% and people are like, ‘All right. I’m going to take my profits’. They start covering. Suddenly, the stock is up and because the stock is up, people freak out and start covering more.
We saw this all the time. There was this weird behavior in 2007 to 2008 in semiconductor stocks; where they would miss their quarters, but then trade up 10%. It was bizarre.
I thought it would be helpful to just talk a little bit about shorting and see how it might compare to Bitcoin. There’s no MNA in Bitcoin. Being wrong on Bitcoin would mean something else; probably things that we haven’t thought about that much or aren’t able to predict, let’s say. Say, overnight there’s some massive Lightening Network adoption; like, it triples, quadruples. I don’t know if the price would go up a ton immediately, but it probably would rise because it indicates that people are locking up their Bitcoin and the Lightening Network is working, or whatever.
Faizaan: Yes. We’ll see how that stuff plays out.
Vikram: Another interesting thing, we talked a little bit about these miners; professional miners, institutional miners. I saw a Bloomberg article recently about Bitmain; these guys make ASICs for a ton of — actually not a ton of Cryptos, for a handful of Cryptos, Bitcoin Cash, Decred (I think they announced recently). So, they are mulling an IPO.
I thought this was kind of interesting because every time I hear about Bitmain now, Nvidia comes to mind. Nvidia is a GPU company, based out here in the US. So, Nvidia went public in 1998. I’m sorry; I think they went public in 1999. The nine months prior to them going public, they were at $92 million in revenue. Latest quarter they did $3.2 billion. So, it is a pretty massive growth over 20 years. Over 20 years, though. Their IPO; back then maybe it was decent size, but today people might scoff at it a little bit to $12 per share, and they raised $40 million from the public. Drop in the bucket these days.
Just a fun fact; if you invested in a hundred shares post-IPO in Nvidia, that would have been a year right after they went public about $2,000, as of November of 2017 — this estimate comes from Investopedia — that money with reinvested dividends would be worth $274,231 today.
So, Nvidia is a pretty interesting stock. We followed this stock pretty closely and it basically traded on pricing. People tended to not care about revenue as much as they did about pricing. The reason pricing was so important is because it affected their margins dramatically. A small few percent change in pricing could affect their margins pretty severely. They actually quote that in their IPO filing. So, even though it’s 20 years old, it still matters and I’ll just read it here.
Faizaan: Right.
Vikram: ‘For example, in the quarter ended July 26, 1998 the company experienced substantial declines in gross margin from the previous quarter due to increased competition from new products introduced by both the company and its competitors for the 1998 design cycles’. I don’t know what was going on in GPUs in ’98, but they and, my guess, maybe AMD had a turf war around that time.
Faizaan: Yes, I think that’s when I bought my first GPU.
Vikram: Oh, really?
Faizaan: It was a [Inaudible] [35:33] thing. I just vaguely remember it. Back then, it was a pretty specialized item and I think it had 32 megs or something ridiculous now.
Vikram: Over the years they’ve been able to. It was a pretty cyclical stock for many years and then over the last few years it’s just been doing really, really well. I think it’s not just because of Crypto and GPU demand. If you just forget that; maybe that’s the underlying factor, but if we’re just talking about financial metrics, they’ve had really favorable pricing and really good margins over the last few years. For example, in 2014 gross margin was 54%, in 2015 it was 56%. This jumped to 60% in 2017 and now it’s nearly 65%. This is a hardware company. In pure software you see super high margins, but this is a hardware company and it’s pretty awesome to have margins like these.
Faizaan: Yes. What’s interesting about their hardware product is that it’s not really directly replaceable. What I mean by that is, like AMD makes GPUs as well, and with CPU it isn’t what the GPU is; it’s almost generational. Like, Nvidia will launch something and it might capture a little more market share if their pricing is good, and then if AMD launches something that’s better pricing for most of the performance, it might swing a little bit of market share that way. I feel like in the last decade you’ve seen more, not just ‘Oh, what’s your performance per dollar’, but functional specialization. Nvidia invented their own low level language, like Cuda, to help people write stuff for their GPUs. They’ve expanded into not just the GPU but physics rendering device, and then I think now both of them have it, but they were the first to roll out the ability to have multiple GPUs and just paralyze them in consumer grade hardware.
So, it was a lot of things. It wasn’t just about performance per unit of power, but some fundamentally different or structurally different capabilities, and the competitors always catch up and it goes back and forth. Maybe, that’s not a factor in the price or margins.
Vikram: Yes. The way you described is basically just highly specialized tech. So, their software layer is actually super important for their hardware.
Faizaan: Maybe machine learning and AI stuff also has a lot to do with it because basically all the training for these models, a lot of that’s very GPU intensive.
Vikram: Yes. I just wonder how all this stuff will play out for Bitmain. They’ve only been around for a few years now. They’ve gone from nothing to billions in revenue in a very short amount of time. So, if you compare that to Nvidia; it took a much longer time, albeit in a different market. This Bloomberg article; I’ll just read a little piece from it. ‘In an interview with Bloomberg News, Wu, as in Jihan Wu, said Bitmain booked $2.5 billion of revenue last year and that he and his co-founder Micree Zhan together own about 60% of the business. While Bitmain has few direct comparables, applying a multiple similar to that of publicly traded chip makers, like Nvidia and MediaTek, would give the company a valuation of about $8.8 billion.’
So, yes, they’ve benefited 100% from Crypto Bitcoin, in particular, by developing custom ASICs and then as they have been developing other custom ASICs for other coins, like Bitcoin Cash and Decred. I think there was a rumor if; unless it happened, I didn’t keep up with this; they developed one for Ethereum too. But yes, the ASIC first GPU stuff is pretty, pretty interesting as well.
Faizaan: Yes. I’m obviously not an electrical engineer so I don’t understand it down at the structural level, but with the ASICs, they’re very specialized for this specific caching algorithm they’re trying to solve for, whereas GPUs, while much more specialized than CPUs, they’re still basically a more general architecture for just massively parallel computation. So, they’re never going to be as good at any specific algorithm as ASIC; which is designed just for that.
Vikram: The interesting thing there is how that gets into the concept and notion of scarcity or under digital asset. If it’s easy to mine something, not that GPU mining is easy, you’re still putting up capital to do it, but ASIC mining certainly is harder; it is more capital intensive, it’s more technically intensive, et cetera.
Faizaan: I guess you could say the probability of being able to find the exponential gains, like what happened with Bitcoin, the mining capacity of a modern ASIC is, I don’t know, maybe millions; some huge multiple compared to a laptop back in 2011. So, the dynamic there is probably very different from something that is much more constrained in how much exponential growth you can have for the individual. Like, per dollar, I guess, would be the metric to base it against.
Vikram: Right. So, you sent me this from your newsletter. It was the Opera versus Brave Browser wars. I’ll quote, ‘Is it time for the Crypto browser wars? The once beloved opera browser is now a scrappy underdog. It holds a 3.2% market share today; behind Firefox at 5.4%, Internet Explorer at 6.1%, Safari at 13.5%, and Chrome at 55.2%. Those numbers could see some change, as Opera has just released a Crypto wallet built into the browser itself. This would allow users to interact with decentralized applications natively, store, send, and receive Crypto and ERC20 tokens in the browser, and does not require third-party plugins or wallets. For the mobile version, biometrics could function as a password.’
Faizaan: Oh, interesting.
Vikram: Yes. So, I guess the implication here is that by them being first to market on some of these features, they’ll be able to recapture some market share.
Faizaan: I have a few thoughts on that. I think I am old enough that Netscape was my first browser when the only options were Internet Explorer or Netscape. Then I had Windows for a long time, so the default was Internet Explorer. Then when Firefox came out it felt like a big jump because I think Internet Explorer hadn’t been getting much better because they didn’t have to, and then Firefox brought some competition to the market. Then when Chrome brought out, you know, the one process per tab, I jumped over to Chrome. Then what you saw happen once you had multiple browsers and browsers supporting different levels of standards was; I think, Chrome captured a lot of market share because they just pushed ahead of everyone else because they were okay with putting stuff into their browser that wasn’t even necessary; how the other browsers hadn’t caught up to and people started building stuff for Chrome. It basically solved all the problems that Firefox did, but was much more performing. I don’t know that that’s true anymore. I think Firefox rebuilt their rendering engine using, I want to say, something called Servo and Rust, but I might be completely off.
Vikram: My issue with Opera is that, nowadays, between Firefox Edge and Chrome, there’s a bit of discrepancy in the features they support at the cutting edge, but they all move within lockstep when it comes to this stuff that your average user cares about. Stuff related to Crypto is being on-boarded so quickly that I don’t know if people are going to switch to Opera because it has functionality that they don’t have in Chrome and they don’t want to get from a Chrome plugin. So, I don’t know that the UX is compelling enough to bring people over.
Faizaan: I think you’re just going to have those safari and IE percentages; they are probably just people that use the browser that’s by default. Firefox and Chrome is more of a conscious choice. I don’t know what is that compelling about having a browser with built-in support versus plugins; like, Ledger had Chrome apps for a while and now they have their standalone app. So, what are your thoughts?
Vikram: I’m for them trying this to see how, you know, it’s a nice experiment. Let’s put a Crypto wallet built into your browser and see what happens. There are probably security things that’ll come up. There’ll be the UX considerations or whether people will use it or not, but I probably agree it’s not like people will run to the browser, to this browser, to use it. There will probably have to be some reason to use it. I guess it lets people store and send and receive Crypto. What is this? Does it serve as a wallet as well? I don’t know. I’d like to see what it actually looks like because my initial reaction …
For me, it’s not a compelling enough case; switch browsers and all that comes with that.
Now, I wonder if there’s a case where you might want to use two browsers. I don’t. The only reason I use multiple browsers is with development, like I’m testing different functionality across different browsers to make sure it’s supported; but there’s really no reason for me to say, ‘Hey, I want to use Firefox for this one thing because I like it’s feature better’.
Faizaan: I did use Opera Mini for a while on mobile just because it was a lot better than the native offering. So, it needs to be a pretty significant delta for people to go to a third-party browser like that.
Vikram: Yes. The skeptic in me is probably thinking there is some major security concern around this, and I don’t know what exactly, but that’s what it seems like. So, we’ll see. It’s worth watching.
Faizaan: All right. So, you know, once again this week we had a bunch of interesting alerts come through in our system. We can discuss some of those. Now, in one of the previous talks we had talked about, you know, 2nd Layer Networks. The big milestone was worse but we’ve been staying pretty steady growth of the Lightening Network. It crossed the 80 BTC in capacity. It’s well over 2,500 nodes now. So, that’s an interesting metric. It’ll be a great milestone when it hits a 100 BTC.
Vikram: Yes. It’s really taken off. I think it climbed very quickly to the 20 BTC level, was like 25 for a little while, then it went to 30 pretty quickly, and then it went to 50 in a few days, and now it’s, I think you said, 80.
Faizaan: Yes. Yes.
Vikram: Okay. That’s tremendous growth.
Faizaan: So, I wonder what the deal is there.
Vikram: It’s definitely worth investigating.
Faizaan: Any investor who wants to hold the BTC and has some interest in the Lightning Network, this is an example of an alert that really perks your ears up.
Vikram: There is something interesting I heard recently about the Lightening Network and I want to investigate it more before. I think we should actually have a whole podcast about it because it’s super interesting, and well I’ll get your thoughts here too.
Faizaan: Sure.
Vikram: This is something you brought up a lot. I think you had read, I don’t remember which book it was, but it was the PayPal founder talking about chargebacks and how much companies spend on handling fraud.
Faizaan: Yes. I think it was Founders at Work by Jessica Livingston?
Vikram: Yes.
Faizaan: Max Levchin.
Vikram: So, a lot of these companies spend quite a bit on chargebacks, fraud protection; things like that. I think Zappos as well; the shoe company. One thing that the Lightning Network offers is a trustless way that’s 100% secure to handle transactions. I don’t understand it enough yet to explain how and why, but let’s just assume that that’s the case, even though it sounds like a pretty fantastical case. Let’s just assume that’s the case. That should drive adoption by a lot of these companies that spend a ton of money on chargebacks and fraud prevention because if they can no longer spend that, their profits will go up. So, anyway, it’s worth looking at. It’s gone from 20s to 30s, 50s, 80s within this month. It’s just a pretty crazy growth. So, I’d love to know what’s going on.
Faizaan: Yes.
Vikram: If any listeners out there actually have a better understanding of this, we’d love to hear from you all.
Faizaan: Yes. Another one that came through, that I thought was interesting, was, you know, Coinbase has been making a bunch of acquisitions. I think they bought a company called Keystone and a few others, and their spokesperson Elliott Suthers; told Bloomberg they were approved to acquire the ownership of the licenses of the three companies.
Vikram: Okay.
Faizaan: But then the Vice President of Communications Later said that it is not correct to say that the SEC and FINRA approved Coinbase’s purchase of Keystone because SEC was not involved in the approval process. The SEC’s approval is not required for the change of control application. Basically, reddit comment. So, Coinbase talks to someone at SEC who gave Coinbase the thumbs up, but that thumb had no authority.
Vikram: That’s hilarious.
Faizaan: So, just a little bit of, you know, drama in terms of they put out one statement, turns out it’s the other case, and maybe they got an okay, but it’s from the wrong person. So, just fun stuff to follow. It just popped up on my feed, so I thought I’d share.
Vikram: This is like the first time I’ve ever seen financial news just wrong so often. Bloomberg and Wall Street Journal, there’d be some vetting process, but now, Crypto industry is full of so many rumors; things just fly around. How did this happen? How would you announce this? I don’t know. It’s just really fun.
Faizaan: I was just clicking through the end right now and another just a [Inaudible] [49:54] telegram thing popped up. One of the admins for VeChain and is just saying that token swap service on wallet will start in August. You have two options: one, move to exchanges once they announced their tokens swap date; or two, wait for tokens swap service and wallet. Nothing else needs to be done.
I thought this was interesting because one of the things we always see is people asking when is the exchange going to support this, when is the exchange going to support that? So, it’s interesting to see that. Again, telegram is where a lot of this stuff is getting announced first.
Vikram: Yes, it’s pretty awesome that we get so much out of those telegram alerts. Like this example you just gave right now, there’s always something popping up.
Faizaan: Yeah. There’s another thing that I thought was interesting. So, obviously, we’ve talked in the past about market manipulation, and a big concern that people have is that there’s a lot of market manipulation going on because with a lot of these coins, I don’t think it takes that much capital to do that. So, Coinfloor; which is an exchange that has a bunch of subsidiary exchanges; is working with a company called Trading Technologies International. They are going to be using some machine learning based market manipulation detection that has, I guess, been used in traditional finance. So, we’re seeing some of that stuff come to Crypto exchanges as they, sort of, become more professional operations.
Vikram: Yes. That’s cool. Also, I’m all for more professionalism.
Faizaan: Yes, exactly. Another fun one: ‘Fed Chairman: Cryptos have no intrinsic value’, so make what you will of that. There was another congressional hearing on Crypto today at 2:00 PM. I actually saw that because the link just came through in our feed.
Vikram: Nice.
Faizaan: I’ll go watch that later and see if anything interesting came out of it for next week’s podcast.
Vikram: Yes. I saw a tweet about that hearing. There was the Agricultural Committee. I always had to kind of funny that they do the Crypto currency stuff. I don’t know, maybe it has to do with commodities or something. Then there was some financial means committee hearing on Crypto currencies, and Brad Sherman again. I think we talked about him on our first podcast. He’s a democratic member in California and he’s heavily against Crypto and, I think, he said something like ‘the US Americans should be banned from buying and mining it’.
Faizaan: He’s the one that got [Inaudible] [52:54] from everyone for asking dumb questions in the first hearing –just to put it bluntly.
Vikram: Maybe, but he’s angered a lot of people.
Faizaan: I think I know what you’re talking about. I just remember his big goofy smile and he asked dumb questions.
Vikram: I don’t even know how they could do that. Even if they wanted to, I don’t know how they could do it at this point.
Faizaan: Yes. That’s the guy I’m thinking about. The last thing that I had, again, this is something. You know we saw the price move yesterday and then this popped up in our feed. Apparently a billion dollars entered the market in about an hour, or nearly half a billion dollars, but that’s what caused the almost 700+ dollar price spike rate. And some 55 million in five minutes at 6:40.
Vikram: Wow. That’s crazy. Cool. I know some of you guys have asked us about our ‘When is the Big Drama in Small Cap Land’ segment coming back; it’s coming back next week. So, stay tuned.
Faizaan: Yes, and we’ll be also talking about IOTA in detail.
Vikram: Yes. It’s very controversial probably. I don’t know. What do you think, Tesla [Inaudible] [53:33]? What’s more controversial?
Faizaan: In the Crypto space, I would say IOTA.
Vikram: Well, I would say Tesla is more controversial because I think there are more legitimate positions on both sides.
Faizaan: You will explore what that means more next week.
Vikram:Right.
Faizaan: All right. Talk to you soon.
Vikram: Alright.
Show Notes:
Topics:
- Short selling Bitcoin
- Mechanics around shorting
- What shorting is
- How shorting works
- Key things to get out from all the mechanics talk
- The reason people are bullish and bearish about Tesla
- Discussing a highly controversial stock
- The mindset of shorting
- Benefits of shorting in psychology
- Types of shorters and its examples
- Downsides of shorting
- How Nvidia trades
- How Nvidia relates to recent news of a Bitmain IPO filing
- Crypto browser wars: Opera versus Brave
- Reviewing some alerts
- Lightning network steady growth
- Fed chairman says cryptos have no intrinsic value
- Live congressional hearing on crypto
- $1B entered market in 1 hour
Links:
- How To Short Sell Bitcoin, And Why More People Aren’t — https://www.forbes.com/sites/oliversmith/2018/07/12/how-to-short-sell-cryptocurrencies-and-why-more-people-arent/#162597724e63
- S3 Analytics: TSLA Shorts Nearing the End of the Road — https://www.s3partners.net/Research/TSLA13.php
- TheStreet article: What to Know Shorting Bitcoin — https://www.thestreet.com/story/14414500/1/what-to-know-shorting-bitcoin.html
- Crypto’s 32-Year-Old Billionaire Mining King Considers an IPO — https://www.bloomberg.com/news/articles/2018-06-07/crypto-s-32-year-old-billionaire-mining-king-is-mulling-an-ipo
- Nvidia IPO filing — http://d18rn0p25nwr6d.cloudfront.net/CIK-0001045810/327515c2-03c2-4795-8946-5968098fa73a.pdf
- If You Had Invested In NVIDIA Right After Its IPO — https://www.investopedia.com/news/if-you-had-invested-nvdia-right-after-its-ipo/
- Nvidia Gross Profit Margin — https://ycharts.com/companies/NVDA/gross_profit_margin
Hey everyone, this is Vikram again. Thanks for listening to us. If you’re
an exchange, a trader or working on a crypto project get in touch with us.
You can reach us on twitter at https://twitter.com/quantlayer or email us
at podcast@quantlayer.com.
