How Will Bitcoin React In A Financial Crisis Like 2008?

Authored by Charles Hugh Smith via OfTwoMinds blog,

If the ownership of bitcoin is as concentrated as some estimate, then the liquidity issue distills down to the actions of the top tier of owners.

Whenever I raise the topic of bitcoin and cryptocurrencies, I feel like an agnostic in the 30 Years War between Catholics and Protestants. There is precious little neutral ground in the crypto-is-a-bubble battle; one side is absolutely confident that bitcoin and the other cryptocurrencies are in a tulip-bulb type bubble, while the other camp is equally confident that we ain't seen nuthin' yet in terms of bitcoin's future valuation.

I've stated here more than once that in my view the real value of bitcoin will only be revealed in a financial/market crisis/crash like 2008-09. Longtime correspondent Mark G. recently proposed three tests that illuminate some of the dynamics that might come into play in the next financial/market crash/crisis.

(CHS NOTE: gold fell from a peak around $1,100 per ounce in March 2008 to $830 in October 2008. It then bounced back to $1,100 in February 2008. The standard explanation for the sharp decline was that gold was sold off to meet margin calls and other obligations arising from the Global Financial Meltdown of late 2008. That gold was perceived as a reliable store of value may have increased its attractiveness as an asset to sell in the mad scramble to raise cash.)

Here is Mark's commentary:

I propose that the performance of gold in 2008-2009 offers an indicator into how bitcoin is likely to behave.

 

I propose three practical tests for bitcoin.

 

Test 1. Is it possible to meet any sort of 'margin call' using bitcoin directly? Is it possible to do so on a large enough scale to affect market liquidity in any particular market? i.e. are any margin loans or the functional equivalent thereof denominated in bitcoin? In 2008 as "margin calls" flowed in from everywhere, all speculative assets experienced the same selling pressure to raise cash to meet obligations denominated in "money".

 

Test 2. Can the physical necessities of daily life be commonly paid for directly and locally using bitcoin? I mean things like food, fuel, medicine, clothing and local debts for utilities, taxes, rents and mortgages. Or is it necessary to first exchange one's bitcoin for 'legal tender' to conduct these transactions?

 

Test 3. Can bitcoin even be used to financially sustain bitcoin's minimum physical infrastructure of servers, brokers and trading desks? Can it pay leases, electric bills and purchase the servers required for this?

 

Are there any lenders of "last resort" ready, willing and able to sustain bitcoin banks, traders and speculators? If not, and precisely because there is a limited supply of bitcoin, it seems a certainty that the financial failures previously seen in the decades prior to the Federal Reserve Act are likely to recur in the bitcoin infrastructure for precisely the same reason: liquidity crunches appearing.

These are precisely the tests that gold and silver failed in 2008/2009. And until bitcoin is ready to pass these tests I think it too will collapse in any future Global Financial Crisis.

Thank you, Mark. Liquidity is an issue in any financial crisis, as sellers may be unable to find buyers at any price. Bitcoin has two liquidity issues:

1. Will sellers of bitcoin find a bid from buyers if a flood of bitcoins hit the market as speculators sell assets to raise cash to meet margin calls (or simply book profits in volatile markets)?

2. Since bitcoin must generally be converted to local currencies to buy the supplies and pay the bills Mark listed above, liquidity must also include the convertibility of bitcoin to USD, euros, yen and yuan, that is, the willingness of traders to exchange USD, euros, yen and yuan for bitcoin.

A liquidity crunch has the potential to unleash a positive feedback loop (i.e. self-reinforcing feedback loop) in which the absence of liquidity triggers panic that then sparks more selling which then worsens the liquidity crunch which then increases panic selling, and so on.

Another potential factor is the ownership of bitcoin. The topic is complicated because one individual can own a number of exchange accounts, wallets and coins in cold storage. On the other hand, one address might represent more than one owner.

To further complicate matters, an unknown number of bitcoins have been lost, i.e. the keys have been lost in hard drive crashes and the like. There is no way to know the number of zombie bitcoins with any precision.

For this reason, charts of bitcoin distribution refer to addresses, not individuals.

The acronym HODL pops up a lot in the crypto space: hold on for dear life, meaning hold on to your bitcoin, Ether, etc. through thick and thin rather than trade or sell it.

If the ownership of bitcoin is as concentrated as some estimate, then the liquidity issue distills down to the actions of the top tier of owners: if some substantial percentage of major owners are forced to liquidate their bitcoin to cover massive margin calls elsewhere in their financial holdings, the sale of big blocks could overwhelm buyers, creating a liquidity crunch.

If most of the major owners have eschewed debt and margin in favor of cash, bitcoin, gold, etc., then they might be in a position to provide liquidity as speculators dump bitcoin to raise cash or lock in gains.

Given the limited number of bitcoin available to trade, liquidity could dry up very quickly if major blocks are dumped on the market.

Given the strong views bitcoin arouses, it may come down to how many major owners will HODL in a panic-soaked financial crisis, how many will avoid being forced to liquidate their bitcoin holdings to meet margin calls or other obligations, and how many will have the wherewithal and the courage of their convictions to be buyers when volatility soars.

Put another way, beliefs and confidence can generate behaviors and decisions that may well appear irrational to speculators.

I don't know how the market for bitcoin will react in a 2008-type crisis, but the small float of available coins practically guarantees high volatility. How it all shakes out a year after the crisis is another question that's unanswerable.

One thing we can anticipate with some certainty is that one camp will be right and the other camp will be wrong.

Of related interest:

Bitcoin Rich Wallets Distribution

The Bitcoin Wealth Distribution

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Comments

Manthong HRClinton Tue, 11/07/2017 - 13:06 Permalink

  Who G'sAF ?? Look… if you speculated on this early…. Get the heck out before the tsunami tide ebbs………….. It’s supposed to be a currency with some nifty transaction value ….. My guess is that it will revert to something under the price of gold. and I would not give you a $10.00 gold piece for a bitcoin. 

In reply to by HRClinton

Mementoil Stuck on Zero Tue, 11/07/2017 - 14:22 Permalink

We have heard this claim before, but I'm not sure it's true.Yes, gold has dipped during the 2008 financial crisis, but let's not forget that at the time it was at an all time high and many momentum chasers were holding it without understanding WHY it was rising.Nowadays gold is in the shitter. Nobody in Wall Street is holding any gold and therefore in a crisis scenario they won't have any to sell!I think that in the event of a financial crisis , gold will be on a tear.

In reply to by Stuck on Zero

Advoc8tr Manthong Tue, 11/07/2017 - 15:13 Permalink

Good for you ... if only anyone gave a shit what you would give for a BTC ... you and everyone else here have been wrong for a decade and are just hoping / wishing it will faulter ... you missed the boat and are too damn stubborn to climb on board when down to your last breath.BTC holders have no debt .. and even if they do they can default on FIAT debt and no-one can touch their BTC ... they ain't panicing any time soon.  They are the new Elite and they know it.Get in line to pay 100K + when the SHTF

In reply to by Manthong

Justin Case HRClinton Tue, 11/07/2017 - 13:11 Permalink

Eventually, of course, a vicious price decline turns out to be the start of a bubble implosion. The true believers will naturally hold, thinking that it’s just another bump on the road to a much higher price. They will continue holding while all the gains made during the bubble are given back.The worst-case scenario is to be a non-believer and non-participant in a bubble, but to eventually get persuaded by the relentless rise in price that special circumstances/fundamentals justify the valuation and that a large commitment is warranted. That is, to become a true believer late in the game. This worst-case scenario is what happens to most members of the general public.

In reply to by HRClinton

Manthong Manthong Tue, 11/07/2017 - 13:53 Permalink

  Actually, the tulip mania was about bank manipulation and futures …. ….not the f’ng flowers themselves......... Go look it up. and oh... two lips on my drawers....not necessisariy a bad thing. .. and trolls cannot handle the truth and acccept that they are mentally deficient,, bitter, angry and likely abused their children. 

In reply to by Manthong

Fireman Tue, 11/07/2017 - 12:58 Permalink

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Two bit tales from the electronic corral of the banksters and their bitcoin blips of bullshit with about the same credibility as Elon Musk's burning Teslas and Mars voyage, all just a set up to get the sheeple hooked for the final fleecing when the IOU Saudi Mercan petroscrip toilet paper dollah gets flushed and the USSAN Potemkin Village idiot "economy" of global slaughter for the zero 1% (on Chinese credit) finally goes down the pipe with the rest of the Washing town turds. Roll up roll up....Fed Coin...coming to a Ponzi virtual reality near you soon.   "Dear G, Bitcoin is a virtual game that is being made look better than gold or silver, to sell the concept of a world wide virtual currency. It should change its name to “Nintendo Virtual Foolishness,” as its purpose is to win the hearts and minds of a public. After that to construct a “Dollar Index Bit Coin” backed by tickets to Mars from Space Inc. with a picture of Elon Musk. There is no computer game that cannot be hacked, and there never will be.  Regards, Jim Sinclair"   Bitcoin at the incredible velocity of 5 transactions per second is positively Flintstonian in its power, Visa can pump debt at 50 thousand scams a second and youtube can process over 350 thousand delusions per second. And still some folks imagine this ethereal "currency" WILL go global and can't be jammed and hacked! Good luck with that when the big money decides to pull the plug not to mention the much ballyhooed Korean EMP fries USSA and the lights go out for 20 years, then of course you will be able to "invest" your leftovers in their "Fedcoin" scam and the rigged "market" can continue on its merry way in our cashless gulag "all watched over by machines of love and grace".   Blipcoin vanished after the lights went out in Puerto....Pobre! https://www.youtube.com/watch?v=GjzeFOKUR04