Will Crypto Be The Next Black Swan?

Bubbles invariably lead to systemic risk in our insipid era of globalism. Everything in world finance is so recklessly tied together through derivatives that herds chasing yield can inflate even the smallest markets to a size dangerous enough to crash the world economy.

Will Bitcoin be the black swan bubble that finishes us off? Or will it liberate us from banksters? Good cases can be made for both scenarios. Crypto is not my area of expertise by a long shot, so I’m just a dabbler and sit in the neutral/skeptical camp personally. (I tend to think anything that can’t be explained to the average person in 10 seconds can never be widely-accepted money.) So the more points of view, the better as far as I’m concerned.

The writer below makes many intelligent points that I’d not considered before. Well worth the full read. Excerpt is below.

From Coin Desk:

Recent news stories make it pretty clear that the new people in bitcoin 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.

Fortunately, I was reading CoinDesk this afternoon and the reporting from the Consensus:Invest conference delivered:

“Dan Matuszewski, the head of trading at Circle Internet Financial, said during a morning panel that there is a ‘real strong need’ for the ability to borrow in this market.

It would not only facilitate short positions but also provide working capital for trading desks to make markets, he said.

During his talk, [Max] Boonen of B2C2 acknowledged the irony of the situation given that bitcoin was born as a reaction to the 2008 credit crisis.

‘Bitcoin enthusiasts really, really do not like credit,’ he said. But, he added, ‘for better or for worse, credit is an important part of a functioning and liquid financial market…’

…Even before the institutional money started flowing in, he noted, ‘by necessity, credit did creep back into bitcoin and crypto markets in general,’ with the major exchanges offering leverage to the early retail investors.”

So someone’s lending directly into the market, we just don’t know who, nor how much, nor where the liquidity for these lines of credit is ultimately coming from.

Leverage sneaks into the ecosystem in other ways, too; for example, Coinbase accepts credit cards, which is basically margin trading for grandmas, without collateral and with 20%+ rates of annual interest.

Given that rather a lot of people seem to be interested in buying bitcoin in this way, and that platform is racking up a few hundred thousand new users a week, there’s undoubtedly systemic risk building up there.

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