Bitcoin looks like it’s heading towards a major crash. If it happens, crypto-millionaires will be hit hardest while governments move to regulate the cryptocurrency.
The way media and experts are nearly universally labeling bitcoin’s vertiginous price surge a “bubble” is just another bizarre episode in the cryptocurrency’s odd saga. Generally, bubbles are not called as they happen. Like financial Rumpelstiltskins, the moment you dare speak their name, they either have already burst or are very close to doing so.
“Bubbles usually get identified in retrospect,” says William Derringer, an MIT historian who has extensively researched financial bubbles. “If we knew with absolute certainty that Bitcoin’s was a bubble, it would have already popped.”
Apart from the popping part, though, bitcoin’s hike ticks almost all the boxes on the bubble checklist. Like bitcoin’s surge, Deringer explains, most bubbles erupt off the back of novel technologies (think of the dot.com bubble in the noughties), often coupled with some form of financial innovation; bubbles also swell as a result of constant media coverage, which causes more and more FOMO-riddled investors to join the craze; and, of course, you have a bubble when speculation drives an asset’s price tremendously above its fundamental value (that’s tricky with bitcoin, as we can’t tell what the fundamental value of a string of cryptographic code is.)
Investors don’t seem to care about the red flags. Bitcoin’s price has soared from January 2017’s $800 to today’s $17,000, with plenty of ups and downs on the way. The debut of bitcoin futures on two major exchanges – initially expected to bring down Bitcoin’s price by allowing investors to short it, i.e. bet against it – has ended up giving the cryptocurrency more legitimacy among retail investors, further boosting its price.
All the same, it’s worth wondering what could happen if bitcoin crashed. If, in other words, bitcoin’s price really was in a bubble, and the bubble popped – whatever the reason (hack, state crack-down, market manipulation). How bad would that be? And how would it play out?
Some think that, as things stand, the harm would be limited. While investors are increasing by the day, most of bitcoin’s estimated $366.8 billion market value is held by a handful of super-rich, ranging from early adopters, to Silicon Valley bigshots and coin barons running cryptocurrency mining operations.
“Most of bitcoin’s value is held by a few thousand very, very wealthy people who would simply become a bit less wealthy. I would expect no meaningful general impact.” says Ari Paul, an analyst and chief information officer for cryptocurrrency investment firm BlockTower Capital.
But some collateral damage would be inevitable. A sudden fall in bitcoin’s price may put pressure on exchanges – companies converting Bitcoin to state-sponsored currency like dollars or pounds – with hordes of coin-owners trying to cash out of their bitcoins before a further slump in value. This reverse stampede, compounded by many exchanges’ notorious lack of liquidity, might leave more than a few casualties on the field.
“It will be like 2000, when the tech bubble popped,” says Garrick Hileman, who researches monetary systems at the University of Cambridge. “The largest and strongest players, the Amazons of the crypto world, will consolidate and propel themselves further ahead. But a lot of bitcoin companies – exchanges, wallet companies, etcetera – will go out of business.”
Some of them could make a last-ditch attempt to pivot. Remember 2014, when, after the collapse of Japanese Bitcoin exchange Mt Gox, people forgot about disgraced bitcoin and started waxing lyrical about the blockchain? “The cycle could repeat itself,” says Hileman.
There may be contagion. Cryptocurrencies such as Ethereum, Litecoin and Monero that have rocketed throughout the current surge could wind up being tarred with the same bitcoin brush and fall in value. According to Hileman, companies making hardware to mine bitcoin and other cryptocurrencies are similarly bound to get a drubbing in a post-pop scenario. “Nvidia, Intel and other chip-makers are definitely exposed,” he says.
Hileman and Paul concur (together with several other economists) that a grave, 2008-style crash is a far-fetched possibility. Past systemic crises were fuelled by people getting in debt to fund their investment. “To have a major financial bubble you’ll need a lot of lending and credit to build up,” Hileman says – and he does not think bitcoin has witnessed that just yet.
But that may already be changing. Cryptocurrency entrepreneurs have already started speaking at industry conferences about the necessity for “leverage” , “lending” and “credit.” Just days ago, the FT revealed that Japanese crypto-exchange bitFlyer let investors borrow 15 times their cash deposit to buy bitcoin. And let’s not even mention the anecdotes about people remortgaging their houses to buy a slice of the bitcoin cake. A bigger, lending-driven, bubble might affect more than a couple crypto-millionaires’ wallets.
Whatever its severity, a bubble-pop would have at least one consequence: more regulation. As an increasing number of people – and even institutional Wall Street investors – join in the bitcoin mania, financial authorities worldwide will adopt a more interventionist stance. In fact, this is already happening: South Korea held a meeting on bitcoin two weeks ago and this week France’s minister of finance demanded that the G20 discussed stricter bitcoin regulation. A bitcoin crash would only precipitate what is underway, explains Brent Goldfarb, an associate professor of management at the University of Maryland.
“It would create regulatory pressure on the currency,” he says. There would be an upswing in complaints and political pressure to do something about [bitcoin]. That’s what created the US Securities and Exchange Commission, which was established after the crash of 1929.”
Granted: enforcing regulation on a digital currency designed to be borderless, stateless, and anonymous would certainly prove tough. One obvious thing for governments to do would impose stricter rules on cryptocurrency exchanges in a bid to avoid the excesses we are witnessing right now. Will that work? Probably not for hardcore bitcoiners. But, Goldfarb thinks, retail investors of the get-rich-quick type would steer clear, at least initially.
Bitcoin itself may go back where it was born, among libertarians, crypto-enthusiasts, and darknet spelunkers. Or might be dethroned by another cryptocurrency, one less tainted by bubbly memories, and end up in digital purgatory. But it will not die. Just think of tulips, the unwitting protagonists of a speculative bubble in 17th century Netherlands. “Tulips didn’t disappear after the mania ended,” Goldfarb says. “They are a key part of Dutch economy even today.”