Wednesday, August 14, 2013

How I almost lost $480 speculating in Bitcoins

Since I paid off my student loans in February, I admit I've been over-eager to build my stash. I didn't spend a few months building up my emergency fund. I immediately started investing in Lending Club notes and I-bonds. I also paid off some 0% credit card debt that's not due until next March, to improve my credit score in anticipation of applying for a Home Equity Line of Credit (HELOC).

There's another speculative investment I dallied in that I haven't mentioned on this blog: speculating in Bitcoins! I've waited long enough. It's time to come clean.

Even before I paid off my loans I've been thinking of what to do with the money I'll save. Even at my relatively unMustachian savings rate of ~30%, I regularly save upwards of $1300 per month (roughly; I haven't looked closely at the numbers recently). I know that I'm not the kind of person who can be a totally passive investor, patiently dollar-cost average into a nice index fund over a period of decades. I know that's the recipe for success for over 99% of people, most likely including myself. But I know myself, and I know my flaws, and I'm always going to have the urge to tinker and optimize and analyze and try to seize opportunities. I definitely do not want these traits to manifest as constantly turning over my stock portfolio: racking up trading fees, buying high and selling low. (As an example: last year I made three ~$300 trades in JCP and MSO, only to sell them within a year at a slight loss. I consider that a cheap lesson about what not to do in the stock market.)

With this in mind, I try to play to my strengths and work around my weaknesses. I want to keep a relatively small part of my stash in speculative investments that will take the lion's share of my time and attention, so that the majority of my wealth can be safe to do the passive compounding thing.

This is where I tell you about Bitcoins. The Bitcoin Wikipedia article is pretty good at giving an overview, but for this discussion Bitcoins are just a commodity to be traded. The key features are very low transaction costs; no need to physically accept, store, or deliver any product; and (at the time) very large price swings, often 10% in a single day. The theory is that by providing liquidity to the market, I could take advantage of large and consistent price swings by buying low and selling high.

The biggest difficulty was finding and obtaining a trading account. When I was looking in April 2013, most Bitcoin exchanges were based outside of the US, and those were the biggest exchanges. They could take upwards of two weeks to get a bank account verified and funds transferred before you could start trading. I had my solution when my friend and co-worker who was also investigating opportunities in Bitcoins showed me to bitfloor, a US-based exchange. Bitfloor even allowed transfers in from ING Direct (now CapitalOne 360).

In mid-April I transferred $400 from ING into my bitfloor account, and bought a single bitcoin from that same friend for $80. The bitcoin transferred to my account in an hour; the cash took around a week. My trading strategy was the following: place many small orders around the current bitcoin price, in small increments. As the market price rose (or fell) and my orders got executed, place additional buy or sell orders surrounding the market price. For example, let's say the market price of a bitcoin was $80. I'd offer to buy at $79, $78, and $77; and I'd offer to sell at $81, $82, $83. To make things simple I used increments of $10, and in practice I often had a dozen or two orders on the books. Bitfloor incentivized traders like myself to add liquidity to the market by providing a rebate (negative commission) if an order was on the books before it got executed, i.e. if it wasn't a market order.

This was the simplest possible strategy I could think of to profit from the volatility of the bitcoin price. I was placing bids manually so I needed something straightforward. The liquidity rebate meant I didn't have to worry about playing a losing game with being charged commissions. The decision to use fixed-dollar trades meant that when I bought at a lower price, I'd buy relatively more bitcoins; then when I sold at a higher price, I sold fewer bitcoins to equal the same amount of money. Using $10 as the trade amount meant I always knew how many purchases I had cash for. The way I saw it, as long as the market price of bitcoins kept vacillating, I was basically guaranteed to make money.

That was my strategy, and it worked beautifully... for a day. Literally a single day. On April 17th my cash cleared into my bitfloor account and I started trading. I was doing pretty well, up about $30 from making dozens of trades. That same day, bitfloor announced it would be shutting down operations due to "circumstances outside of [their] control". I finished the day with $509.27 in my account, meaning I made $29.27 in a day of trading, or about 6% in a single day. At that point my cash was locked up and I basically didn't know if I would see my money or not.

I'm pretty sure that over time I would have been able to improve my methods and deploy more of my cash — I didn't have most of my money tied up in trades that first day — and so I think I could have improved my rate of return. The thought of earning 10% per day is pretty awesome, and at that rate money compounds pretty quickly. Of course, since then the market has settled down and we're not seeing anywhere near the 10% swings we used to (though I haven't kept close tabs on bitcoins). On the other hand, I didn't fully account for risk of loss associated with the trading platform imploding.

Just this week I got my money back to the tune of $504.27: a $5 transfer fee was assessed. I'm pretty happy with this outcome as I could very well have lost my $480. I learned a lesson about what else to look out for with speculative investments, and I gained some valuable experience. I am planning on always keeping my eyes out for speculative investments in the future. It's something I enjoy, there is potential for outsized returns, and it's a liberty I have now that I'm (mostly) debt free.

I'll let you know what other kinds of speculative shenanigans I get myself into in the future.

6 comments:

  1. CrucialDebtCrusherAugust 14, 2013 at 4:59 PM

    Thanks for the info. I had been playing around with Bitcoins earlier this week, but the distinct feeling washed over me that I was wasting time that could be better spent elsewhere.

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    1. Hah, nice. Yeah I had fun while it lasted, but reading a book on investing would be much more valuable.

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  2. " But I know myself, and I know my flaws"
    AWESOME. Its rare to see people admit their flaws and work around them instead of trying to will power through it.

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    1. Another one of my flaws is low will power :)

      But seriously, I'm in this for fun as well as money. To the extent that I can invest in something I find interesting without taking on too much risk, that's something I want to do.

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  3. "A Random Walk Down Wallstreet" is my favorite investing book. Speculating is fun, but I'd definitely Index the majority of your savings. Maybe reserve like 10-20% of your monthly savings for speculation?

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    1. I'm (mostly) indexing into my 401k (9% of gross salary, including match). Long term I want most of my wealth to be in dividend stocks, but until I'm willing to invest over $1000 per month into a single stock per month, I'm going be playing with more alternative investments than probably is wise.

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