The Bear Case for Crypto, Part II: The Great Bank Run
prestonbyrne.com
prestonbyrne.com
The author appears to lack basic understanding about how markets work in this space.
1) enough coin to satisfy coin withdrawals, even in the middle of a panic run
2) enough fiat to satisfy fiat withdrawals, even in the middle of a panic run
I think maybe that's what the author meant, not sure. But if the exchanges fail to show their customers' assets, they will reinforce any panic feedback loop that might be happening sometime in the future.
"The most obvious way, in my view, that Bitcoin mania will turn into Bitcoin panic is when a Bitcoin depositor goes to sell their BTC for dollars – and there are no dollars available to satisfy that sell request."
coinbase has to have the dollars to let me withdraw those dollars from coinbase to my bank account. They may not have enough on hand.
BTC: $160B market cap, ~$5B traded/day
INTC: $200B market cap, ~$1B traded/day
So if there was panic selling of INTC, the stock would presumably dive deeper and lower than a panic sale of BTC...
But this is only a problem if coinbase or whoever is acting as a fractional reserve system.
As far as I know, every single dollar and Bitcoin that coinbase "says" you have is actually in an account somewhere, dollar for dollar and Bitcoin for Bitcoin.
If this is NOT true, and coinbase is a fractional reserve system, that would be a huge scandal.
According to the Bitcoin protocol, only a maximum of 21m BTC can exist. And that they are created via mining in a predictable schedule.
Respectfully, I think you need to revisit Bitcoin fundamentals.
At least, that's my view. We'll see if there's a flight to liquidity when the bubble in Bitcoin's price finally pops.
That's a reasonable position to have. I think it is overpriced too.
It still doesn't make it a 'fractional reserve system'. It instead means that the price is to high.
These are different things, that have nothing to do with each other.
It's not going to go to 0 ever, unless its replaced by another de facto crypto as the face of the entire industry.
It's a deflationary, uncontrolled currency in a world that prints wealth, its easy to see why people want to hold some money here.
Now, since the difficulty changes over time I could imagine that not being as high as people think (e.g. if mining companies abandon bitcoin for other currencies), but there is a real world equivalent to book value.
Call it Instachain or something.
If the history of technology is any indication it will become obsolete before becoming devalued as cryptofinance people move on to better scams / technology.
Where else, besides the crypto-currency market itself, is "wealth" being "printed"?
Fiat currencies may be inflationary but they're only used to price wealth not actually hold it. Actual wealth, unlike crypto-curency "wealth", is held in stocks/bonds/land/etc which are actual assets backed by some kind of economic activity or physical scarcity. Comparing "Bitcoin as a store of value" with fiat currencies is a strawman, you need to compare it with gold if that's what you want it for. If you want to compare Bitcoin to fiat currencies you need "Bitcoin as a means of transactions" and at that it's become terribly inefficient and underused compared to expectations.
Bitcoin is EXACTLY like land and stocks, except much, much, much more liquid and useful.
Starting replies like this is getting to be a theme online. It adds nothing to the discussion except make people argue in extreme and entrenched ways.
>"stocks/bonds/land/etc" are not actual assets backed by anything OTHER than scarcity.
I specifically said they were backed by scarcity (land) and by economic activity (stocks and bonds).
>Stocks have value almost exclusively due to capital appreciation. You don't get anything for owning non-dividend-paying stocks. And owning dividend paying stocks just means money is not being reinvested (notice that Berkshire Hathaway has never paid dividends out).
I have no idea what you're trying to say. Stocks generate value out of an economic activity. That's the value that underlies them. If the company then has enough opportunities to continuously reinvest or if it just gives up and returns value through share buybacks or dividends is not really important to the point that what makes stocks valuable is that the company has some form of economic activity. If you find a stock that doesn't have an underlying economic activity and is just driving up price through scarcity that's not a company it's a Ponzi scheme like Enron used to run.
>Bitcoin is EXACTLY like land and stocks, except much, much, much more liquid and useful.
Bitcoin is digital gold. Useful yes, but wow, you really think its value dwarfs the asset classes responsible for representing the available physical area of the planet and the current economic activity of the planet?
Bitcoin, however, seems to have no practical uses whatsoever.
I don't understand what you're arguing against. First there are plenty of stocks that do return dividends (or do stock buybacks which are equivalent). Second, pricing may be suboptimal, maybe non-dividend stocks should be worth less[1] but it's still pricing something. Bitcoin is just pricing digital gold.
You're also going into the pattern of taking a comment and very vehemently discussing a small part of it as if that's what's being discussed. The initial OP assertion was that somehow fiat currencies are "printing wealth" as if printing dollars is somehow printing wealth, it's not. You've then made an even more incredible assertion that Bitcoin is strictly better than land or stocks because it's more "liquid and useful". Care to explain that? Certainly you're not arguing that Bitcoin is more valuable than all the world's stocks/bonds and all the world's land? And certainly you don't think something that struggles to do enough transactions a day to sustain the current network is actually currently more liquid or useful to the world economy than the capital markets that handle several orders of magnitude more transactions and total value?
[1] Almost certainly not 0 but that's a totally different discussion not worth going into here.
Stock buybacks actually demonstrate my point. You only benefit from a buyback if they pay you more than what you paid for the share. Dividends are a separate issue as they apply to business being undertaken, and few people invest money based solely on dividend rate. IMO land as a speculative asset actually might the most appropriate comparison to Bitcoin.
At any rate, Bitcoin/Ethereum and others are fundamentally new asset classes, they are technologized money. They allow you to do things with value that were never possible before.
> At any rate, Bitcoin/Ethereum and others are fundamentally new asset classes, they are technologized money. They allow you to do things with value that were never possible before.
This is too breathless to be meaningful. Care to name a few actual uses? There's a long way still for cryptocurrencies to demonstrate they actually bring anything of value to the table. From what I've seen so far Bitcoin may be a slight improvement on gold (an asset that's mostly useless these days) and Ethereum may be a slight improvement on complex financial instruments (things that are often actively harmful). I may be completely wrong of course, time will tell.
Most people that evangelize cryptocurrencies would probably be a lot better served by reading up on the basics of investing and start accumulating traditional baskets of assets. There's a long way to go before cryptocurrencies are validated as actually useful and a lot of risk along the way.
He seems to write to an audience that is less knowledgeable than himself, but lacks factual content and is often cringeworthy.
Derivative markets like Bitmex use a form of socialized loss to remove the risk.
This happened to the London interbank lending market during the week of 15 September 2008, when LIBOR jumped to 8% and the banks simply stopped providing loans to each other. The reason? Because they weren't sure the assets their counterparties (other banks) were sitting on were worth anything (resi mortgages) and they didn't want to find themselves an unsecured creditor.
Mortgages during the subprime crisis didn't fall in price so much as they were impossible to price. This made the credit risk of bank borrowers impossible to price. So funding headed for the doors.
Change up the parties a bit and the banks --> offramps, mortgages ---> Bitcoin, and liquidity --> fiat, as in 2008.
There is simply no way that, as Bitcoin goes parabolic, the on/offramps are prepared to handle a change in the weather which results in a huge influx of withdrawals unless their own bank balances rise significantly. My informed supposition is that most such entities should have high-cost liquidity facilities with commercial banks that can step in and address some of that withdrawal demand.
As then, a liquidity shock (availability of dollars) could break the system without needing a precipitous drop in the market price of Bitcoin.
Banks don't provide liquidity to Bitcoin exchanges. Exchanges don't borrow from banks. Exchanges don't trade with their money, or their users' money. Exchange users deposit money to exchanges, and exchanges dumbly execute orders specified by their users. That's it. For example BTC/USD bids on an exchange's order book are 100% backed up by dollars that have already been deposited by users on this exchange's bank account.
In a closed system:
Day 1: $1 buys 1000 Marmotcoin
Day 2: $1000 buys 1 Marmotcoin
Day 3: 1000 Marmotcoin attempts to sell for $1,000,000
That's what the initial phases of a liquidity shock will look like. I can almost guarantee you that retail operations all have bank liquidity facilities to deal with sudden upswings in withdrawal demand, otherwise they have to commit house money to cover it.
That's now how an exchange works.
For the price to be 1,000,000 USD for 1,000 BTC, there must exist buyers with 1,000,000 USD and sellers with 1,000 BTC with orders to trade at that price.
There's no "house money" since exchanges aren't casinos where the players bet against the house. Buyers and sellers are transacting with each other, matching buy orders with sell orders.
The exchange doesn't have to borrow the USD from a bank, the buyers bring the USD to the trade.
There is no "liquidity shock" unless the exchange steals or loses the buyers' USD. And that's a different argument.
For example. If I bought $1000 for 1 BTC from Coinbase on January 1st 2017 and try to exit that position on Jan 1 2018, once I sell that $10,000 bitcoin to Coinbase I'll be withdrawing $9000 more than I put in. Coinbase has to get the $9000 from somewhere, whether that be from other deposits which are more recent than mine, or from its own trading operations.
If you have a large number of people trying to withdraw a large number of dollars at the same time, your offramp could run out of dollars or, in the alternative, be required to (a) draw down a facility with a bank or (b) sell assets. In an environment where the asset price is falling rapidly it may not be able to avail itself of either option.
As occurred in 2008, with dire consequences.
I place the sell order with my brokerage, and I get fiat USD deposited into my account. This is exactly how Bitcoin is exchanged.
Where exactly lies the fundamental liquidity problem for my brokerage/exchange?
yeah, from the person that just bought BTC for $10,000.
Every dollar that a user withdraws from an exchange is a dollar that was (already!) deposited by another user.
Day 1: Alice buys 1,000 Bitcoin from Bob for 1 USD on a street corner
Day 2: Market price on the street corner is 1 Bitcoin for 1,000 USD
Day 3: Alice sells 1,000 Bitcoin to Charlie for 1,000,000 USD on a street corner
The street corner doesn't have to borrow 1,000,000 USD from a bank.
Charlie brings the USD to the trade.
In a panic, you need to flip this scenario on its head. Charlie is not going to show up and Diana, who got into Bitcoin in 2009 and hasn't done anything since, decides to take her profits on 1,000 BTC. So this system has $1,001 to meet $2,000,000 in deposit demand, assuming neither Alice nor Bob has withdrawn their USD and some Bitcoin hodlers pile in.
Particularly popular liquidity pools eg BitPesa or Coinbase may then be put under pressure to either cease operations, draw down liquidity facilities to buy BTC, or start selling their own assets in order meet demand of BTC holders who want to get out. Those are not good choices.
No one is saying a price crash isn't possible. But it won't be caused by some liquidity issue, it'll just be people selling off.
You're essentially saying that the exchange should artificially prop up the price of bitcoin with its own money during a panic.
You simply cannot sell it if there is no buyer to take it. You never 'sell' to coinbase -- this is a front for GDAX, their exchange. Every buy is taken from a seller on their market. The money is exchanged between you and their account, and they take fees.
You use strange language. Maybe the scenario you mean to describe is not about lack of deposits or lack of float, but is a classic panic sale (ie. order books not deep enough to absorb all asks). Yes, this could happen with Bitcoin, or basically any financial instrument: stocks, forex, etc.
As someone who has been trading bitcoins since 2010, I will retort that market depths have definitely been growing over time. I don't have precise data to show you, but for example GDAX's BTC/USD order book accounts for 1/20th of the worldwide BTC trading volume. Right now selling 3600 BTC on GDAX would net $30M and dip the price -20%. Assuming the same depth at other exchanges, this means traders could globally sell 72000 BTC at the same instant for $600 million and dip the price by only 20%. That's a pretty decent market depth.
If market depth grew proportionally to Bitcoin's price, it would mean that 7 years ago when Bitcoin was trading at $0.25 (1/36000th its current price: http://bitcoin.zorinaq.com/price/) then a sale of $16k worth of Bitcoins would have dipped the price by 20%. I don't know if we can find archives of MtGox's trading data from 2010, but I roughly remember selling blocks of 1000 BTC at a time on Mtgox for $0.70-1.00/BTC in February 2011 and each of my sale would dip the price by a few percents.
So my (vague) recollection seems to indicate I'm probably right that market depth increased proportionally to Bitcoin's price. Therefore Bitcoin would have been at an equal risk of a panic sale at any point in the last 7 years. And the fact there has never been a long-term panic sale is a testament to Bitcoin's resilience. The markets are deeper and are more resistant than you think.
You are misinformed. The people who provide the dollars to this market are the customers of the exchanges. It seems like you are not familiar with how a currency exchange works.
A currency exchange does not buy or sell the currencies traded at the exchange. All it does is match buyers with sellers, like an auction house. Buyers must deposit all the dollars that they use to buy before buying, and sellers must deposit all the bitcoins they sell before selling. When someone withdraws dollars after selling, the exchange simply transfers to them the dollars that the buyer deposited earlier. It already has the dollars on hand and does not need to borrow them from a bank, ever.
Now, not all places you can sell Bitcoin for dollars are currency exchanges. There are also brokers that do trade directly with their customers, rather than matching customers together to trade. In fact, Coinbase provides this service. However, they can simply obtain dollars by trading at currency exchanges themselves, and they adjust the price they offer to match the exchange price (plus a fee) so they can't just run out of money. Again, there is no need to borrow dollars from a bank. Furthermore, trading volumes at true currency exchanges absolutely dwarf the volume of any Bitcoin broker.
All that said, nothing prevents a crash in the Bitcoin price. If too many people want to sell and not enough want to buy, the price will go down a lot. But this is true in any market, and it has nothing at all to do with bank lending. Not even a little bit.
I fear you're misinformed. Besides localBitcoins, how does one get fiat to an exchange?
That's right — a bank. Exchanges like Bitfinex only survive because of things like Tether, which requires other fiat accepting exchanges.
If all exchanges were like Bitfinex, there would be a liquidity crunch, as the OP is saying.
When banks refuse to deal with an exchange like Bitfinex, it has nothing to do with liquidity concerns. It's because banks are required by law to verify who they are transferring money to (AML/KYC), and they don't believe Bitfinex abides by those laws (they are right).
BTW, Bitfinex recently reopened bank deposits and withdrawals.
Although that would be incorrect, there still are valid fears for a liquidity crunch, as I stated. This, regardless of why (be it laws or fund availability) does create a concern due to liquidity.
> BTW, Bitfinex recently reopened bank deposits and withdrawals.
Clearly not true. Especially for U.S. customers: https://www.bitfinex.com/posts/227
Also, if the Fed barred any Bitcoin sales/buys with USD (however unlikely) almost all reputable bank would drop those as well, regardless of country. This has been discussed in detail on r/BitcoinMarkets, actually.
I deposit USD to an exchange...then use that USD to place a Bitcoin buy order. Then I sell some Bitcoin another buyer on the exchange, who was only able to make this transaction happen because they too deposited USD or fiat into their account.
I get the money, they get the Bitcoin. Who is getting screwed?
LocalBitcoins would become a seller or buyers only recourse, for U.S. customers anyway, which takes a lot of coordination/time, and essentially becomes an obvious form of money laundering.
This doesn't seem like a fundamental problem due to the structure of Bitcoin or exchanges.
A little less ego and a little bit more self-doubt would do you good since you can't even tell the difference between volume and frequency Preston.
The smart money will start taking profits by selling their coin, as the price goes down those that bought the high will lose their nerve and sell to stem their losses. Then the rest will start selling shortly after. Eventually there'll be nobody willing to buy at any price, it'll be worthless.
As long as there is value in maintaining public blockchains, their tokens (BTC, BCH, ETH, etc) will hold monetary value.
e.g. it's possible, as it has happened before, that a trusted financial institution is playing a dangerous game to make money off sitting cash and uses someone else as a backup.
The real question is: Does Coinbase (or any other exchange) do anything with the money (fiat) and how much is actually reserved? Same with Bitcoin.
We can assume 100% on each side because they make money on fees of the exchange, but that's the real question here.
Also, that doesn't stop you from selling bitcoin into USD.