Bitcoin supporters may disagree, but most experts think that the price increase is a bubble. For them, the issue is when, not if, its price will fall. As a corollary to that issue, what impact would such a catastrophe have?
Will a Bitcoin Price Crash Affect the Entire Economy?
The Financial Stability Oversight Commission recently released a report outlining financial stability threats, and digital currencies received just a short mention. Virtual currencies, according to the organization, have a “very limited” influence on financial stability. This is most likely due to the present size of the bitcoin ecosystem.
Subprime mortgages were the last significant financial tool to disrupt the US economy. That crisis happened as a result of a complicated confluence of events. Mainstream economic actors were active participants in the process. For example, subprime lenders in the United States made defective loans. Large international banks repackaged these loans as derivative securities and sold them to investors, who spread the sales across the economy. Collateralized debt obligations expand the leverage epidemic even farther throughout the globe.
Citigroup Inc. (C) originated an estimated $19.7 billion in subprime mortgages during the height of the crisis. Bear Stearns, an investment bank that failed in the aftermath of the crisis, had a “vast portfolio” of subprime mortgage derivative products.
Bitcoin, on the other hand, has yet to escape its outcast position inside the financial services industry. The price hike happened inside the limits of uncontrolled exchanges that have yet to be scrutinized by regulatory officials. According to recent reports, the primary participants in these markets are individual investors and bots. (For more information, see Why Do Cryptocurrencies Have Buy and Sell Walls?)
Big banks and financial institutions have mostly avoided the bitcoin mania, and their exposure to cryptocurrency markets is minimal, if at all. While bitcoin-related stocks have increased in value, their numbers are still small.
The comparatively modest reaction to CBOE futures trading, despite bitcoin’s price increasing by more than 1,800% this year, reflects the banking industry’s skepticism. Goldman Sachs is allegedly seeking a 100% margin for bitcoin transactions even as a clearing agent for CBOE bitcoin futures. (Also see Bitcoin Futures on CBOEVs.) What Is the Difference?)
Instead of the subprime mortgage crisis, the bitcoin bubble’s demise may be comparable to that of Amsterdam’s “tulip frenzy” in the early 17th century. Tulip prices in Turkey skyrocketed during the boom, with “cobblers, carpenters, bricklayers, and woodcutters” participating.
However, since professional financiers kept away, the drop in tulip prices had a minimal impact on the general Dutch economy. According to Dutch historian Nicolaas Posthumus, only casual merchants bid up tulip prices for greed and profit. In the end, it was these folks who suffered as prices fell. Similarly, a drop in bitcoin prices will cause a sell-off that will effect only a limited number of individuals.
What Will Happen to the Cryptocurrency Ecosystem?
Axios, an online website, has estimated the monetary effect of a bitcoin crisis at $250 billion. However, such estimate reflects a misunderstanding of the usefulness and markets for cryptocurrency. There has already been significant investment in blockchain, the technology that underpins bitcoin. Aside from that, the price oscillations of bitcoin indicate that it is developing as a store of value. Cryptocurrencies may also be used to exchange value inside closed ecosystems.
However, it will take some time for their value to be appreciated in popular applications. Most cryptocurrency prices are now rising as a consequence of a domino effect caused by bitcoin’s increase. A bitcoin price drop is quite likely to cause a correction in their pricing as well. It is also clear that the overwhelming majority of cryptocurrencies now listed on exchanges will vanish. Only digital currencies with well-defined business models and obvious usefulness in mainstream culture will be able to withstand a crisis.
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