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Yesterday, the price of Bitcoin crashed through the psychologically important $10,000 barrier. Cryptocurrency enthusiasts celebrated. “We made it!” cried one Reddit poster. Others looked forward to even higher prices: on Twitter, Adam Back, co-founder and CEO of Blockstream, advised people to sell as little as possible, because “$100k is the next number.” Today, Bitcoin has risen a further $1,000. It is also rising against other international currencies such as the euro and the yen: its value in yen is now over 1m. The sky is the limit, seemingly.
Bitcoin’s meteoritic rise has pulled up the prices of other coins too, to the delight of their owners. “Congratulations to all the hodlers!” cried Litecoin’s Charlie Lee. “This is by far the strongest Bitcoin bull run I’ve seen in 6+ years”.
What is a “hodler”, you may ask? Well, it appears that someone misspelt “hold” after drinking a lot of whiskey, and it caught on, perhaps because cryptocurrency enthusiasts like to pretend they are different from other investors. You don’t “hold” cryptocurrencies, you “hodl” them. Though personally I would call it “hoarding” them. People are buying cryptocurrencies not to use them for transactions, but to hoard (or “hodl”) them in the expectation of profiting from the ever-rising price. How this is compatible with Bitcoin eventually becoming a mainstream payments mechanism is difficult to imagine. When everyone is buying to hold, the price inevitably goes up, which makes the currency less and less usable as a medium of exchange.
But amid all the partying, the sheer incongruity of this price rise appears to have struck almost no-one. Why are people who want cryptocurrencies to replace fiat currencies such as the U.S. dollar rejoicing because they are making profits in U.S. dollars? Charlie Lee's comment is hardly a ringing endorsement of the future of cryptocurrencies:
Now take some profit off the table. You deserve it for believing when no one else around you did.
To profit from Bitcoin’s price rise, you must convert it to fiat currency. Since all cryptocurrencies are rising in price versus the U.S. dollar, there is little profit to be made by exchanging Bitcoin for other cryptocurrencies. You can only realize profits from Bitcoin’s price rise versus U.S. dollars if you exchange it for U.S. dollars. So Lee is now advising Bitcoin “hodlers” to buy U.S. dollars.
Another prominent Bitcoiner took breaking the $10,000 barrier as a sell signal: “It's amazing to see Bitcoin break $10k. The first thing I did this morning was actually sell some. That way I can always say that I sold some above $10k.”
He seems to have called the top. If he is right, then he has limited his potential losses to some extent. But if he is wrong, he faces a dilemma: he will lose all those profits and more if he later decides to buy back in, but if he doesn’t buy back in, he will lose any subsequent gains from Bitcoin price rises. No wonder most people are “hodling”. And no wonder everyone is trying to work out how long the party will last. This is supposed to be revolutionary?
Ah, but it’s not all about profits. “Let us not forget,” said Victor Li on Twitter. “Satoshi didn’t create Bitcoin to make people rich, but to give people monetary freedom.”
This is quasi-religious claptrap. What Satoshi wanted we don’t know, since he has long since disappeared, but it is very clear that his present-day followers primarily want to be rich. Of course, that doesn’t mean they want other people to be rich – after all, if everyone is rich, no-one is. The poor can make do with “monetary freedom” instead. The crypto-rich will free them the shackles of the Federal Reserve, enabling them to use a currency whose creation is entirely controlled by unaccountable crypto-billionaires and whose distribution relies on a market entirely skewed towards benefiting the crypto-rich at the expense of the crypto-poor. Pardon me, but I don’t see crypto-shackles as any improvement on government shackles.
Others see this cryptocurrency feeding frenzy as the start of the hyperinflationary collapse of fiat currencies. Eric Weinstein, managing director of Thiel Capital, said on Twitter: “Against a mysterious world-wide low-grade revolution in the industrialized world, the dollar & other violence backed fiat currency continued their collective plunge against math backed Bitcoin.”
Umm, no. The price of math backed Bitcoin is rising exponentially not because people are rejecting the U.S. dollar, but because they want to make lots more U.S. dollars. This bubble is driven by greed, not fear. It will eventually end in collapse, as all greed-driven bubbles do, but it will be hyperinflationary collapse of cryptocurrencies, not fiat currencies.
And that brings me to this piece by Preston Byrne. Byrne points out that underlying the astronomical price rise of cryptocurrencies is an implicit assumption that investors can always cash out into USD (my emphasis):
The price applicable to everyone’s bitcoin holdings is determined by the then-prevailing spot rate. As the price of Bitcoin rises based on relatively thin trading at the margins, Bitcoin hodlers (yes it’s spelled “hodl,” not hold), who measure their Bitcoin wealth in dollars, mark their Bitcoin “deposits” to market on the assumption they can withdraw at any time by exchanging to USD.
True, exchanges don’t guarantee redemption at market value. But hodlers nonetheless expect it. The current cryptocurrency feeding frenzy is underpinned by an irrational belief that dollar liquidity will always be available. So much for rejecting fiat currency.
As the price of Bitcoin rises, more and more dollars will be needed by Bitcoin exchanges to enable investors to realize their profits. But exchanges don’t have ready sources of additional dollars: they must either attract dollar deposits or borrow dollars from commercial banks at whatever the short-term interest rate is. Exchanges are therefore becoming leveraged, not because they are doing fractional reserve lending as banks do, but simply because of Bitcoin price appreciation.
Byrne explains how an exchange running out of dollars might trigger a Bitcoin price collapse (emphasis in original):
...the market may not have confidence that the Bitcoin reserves held by fiat on/offramps will be able to be sold on that platform at any price. This will place pressure on other platforms and their diminishing pools of liquidity as investors run for the exits.
This is different from a mere fall in price, although a liquidity crunch will precipitate that. This is a question of a wholesale withdrawal of dollar liquidity so severe that it may become impossible to shift Bitcoins at any price.
In such a collapse, the price of Bitcoin – and other cryptocurrencies – would fall to zero. When this happens to leveraged financial assets, as it did in 2008, the assets simply become worthless and their owners lose their shirts. But when it happens to a currency, we call it hyperinflation. Are cryptocurrencies assets or currencies?
The last time we saw a highly-leveraged price spiralsupported by an irrational belief that dollar liquidity would never run dry was the Eurodollar market in the mid-2000s. When it collapsed in 2008, the Fed was forced to support all manner of unregulated shadow institutions, not because they had any right to dollar liquidity but because the consequences if they were denied it were disastrous for ordinary people and the real economy. As more and more financial institutions with connections to the real economy pile into the cryptocurrency mania, the chances of a similar disastrous collapse rise ever higher, and along with it, the likelihood of Fed or even a government bailout.
It is the height of hubris to believe that cryptocurrency exchanges are anything other than a new type of shadow bank, or that cryptocurrency investors are any more rational than other investors. Human nature being what it is, moral hazard exists in the cryptocurrency world as everywhere else. This time is not different.
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