Bitcoin Is an Emerging Systemic Risk

Recent news stories make it pretty clear that the new people in bitcoin clearly have no idea what they’ve gotten themselves into.

Bitcoin is the Gom Jabbar of high finance. Cypherpunks who have populated the space to date hold the line because they do not care about money, and therefore do not fear.

These new people are different. The only reason they are here is the money.

They reek of fear.

When we consider that money from fresh, naive amateurs is flowing into the sector at a rate of millions of people per month, we should also understand that these amateurs are more susceptible to the animal spirits than their stoic, abrasive, less-socially-adept, battle-hardened forebears.

They will be prone to cut and run.

As such, a shock to the system, such as an exchange being taken down in a necessary and overdue enforcement action, could lead to a loss in confidence in the entire cryptocurrency ecosystem as a whole and a stampede for the exits the likes of which bitcoin has not seen to date.

In a recent post on my own blog, I pointed out that bitcoin, by setting itself up as a sort of decentralized bank, was also creating an unreasonable expectation to its new “depositors” that they will always be able to redeem their assets at par, given a wild mismatch between its $200 billion “market cap” and new investor money – which is clearly well shy of that number.

This expectation is dangerous as it means, in the event of a liquidity crunch, people will behave not as people necessarily behave when there’s a sharp sell-off in a stock, but more along the lines of when their bank’s solvency is being called into question. Remember bank runs?

As bitcoin qua decentralized bank is running a fractional reserve with a chronic shortage of dollars, a shock therefore has the potential to not just drive the price of bitcoin down a little bit, but also lead to a major liquidity crunch and abject panic.

Credit comes to crypto

In my post, I wrote:

“In the current environment, there are a number of ways such a shock could arise. To begin with, I seriously question the intermediaries’ and traders’ ability to top up their USD holdings quickly enough to catch up with their depositors’ and counterparties’ paper gains in bitcoin. There is also the possibility that, in the event of a correction or an enforcement action, a risk-averse bank to a major service provider withdraws either credit or banking services to that provider, compromising that service provider’s ability to convert BTC into dollars, provide margin lending, or even to hold fiat deposits at all.”

I had a hunch people were lending into the sector. I just didn’t know the degree of alacrity with which this lending was taking place…

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