Bitcoin was invented to make it easy to send money via the internet. The original intent was to create an alternative system for payments that was not subject to any government control but would function as well as or better than traditional money transfer mechanisms. After it was introduced in 2009 several things became apparent. It could be used as a store of value similar to gold as a hedge against devaluation of traditional currencies. It could be a convenient way to avoid paying taxes. It was an effective way to transfer money without government oversight. And, the market for bitcoins could be manipulated via pump and dump schemes. What has come to pass is a huge number of cryptocurrencies whose values are far above the original bitcoin value and whose valuations fluctuate widely and dangerously. With this in mind we ask who gets hurt in the next bitcoin crash.
Bitcoin and the Value of Nothing
Bitcoin is both a success story and a disaster waiting in the wings. When the price of bitcoin starts to rise, FOMO (fear of missing out) takes over and investors pile in to buy in anticipation of the next rally. This was the case in 2017 when it started the year at $1018 and hit $19,650 on December 15. The disaster happens when those who were pumping bitcoin as the cure for all financial ills start to bail out. After its high, bitcoin fell to $12,839 by December 29, $8,547 by February 2, 2018, and $3,400 by December 8, 2018. This scenario repeated itself with a high of $61,283 in March of 2021 with a fall to $31, 576 in July followed by a peak of $64,400 on November 12, 2021 and a plunge to $38,375.50 as of February 2, 2022. Now the talking heads on business shows are saying to expect bitcoin to hit $100,000 by the end of the year without saying where it will fall back to.
Who Gets Hurt in Bitcoin Crashes?
The Nobel Prize economist Paul Krugman likened bitcoin to subprime mortgages in an article in The New York Times. Neither he nor we have any problem with people buying and selling bitcoin provided that they are clear about what they are doing, how to do it, have the financial reserves to cushion losses, and are not being suckered into putting money into a scheme that they do not understand. Unlike subprime mortgages and the Financial Crisis cryptocurrencies are not a big enough share of the US or global economy to cause a new financial crisis. But, in the last plunge of bitcoin from $64,400 to $38,375.50 the world total cryptocurrency capitalization fell from $3 trillion to $1.7 trillion. For experienced investors who can wait and hope for the next rally this is fine. But, according to Krugman, bitcoin investors do not match the college-educated-white profile of the traditional investor. Rather, 55% of bitcoin investors do not have a college degree and 44% are non-white. His worry is that this largely matches the profile of folks who were suckered into subprime mortgages on homes they could not afford in the run up to the Financial Crisis. He thinks, as do we, that the bitcoin and other cryptocurrency markets need more regulation as they are more about investing than about the original intent for bitcoin to be an efficient money transfer system.
Regulation of Cryptocurrencies
In his article, Krugman quotes the Fed official who asked in regard to subprime mortgages, “Why are the most risky loan products sold to the least sophisticated borrowers?” The same person noted that the question answers itself. The Romans said res ipsa loquitur for such obvious issues. Crypto investment regulation is likely to come sooner than later. The issue is not that non-white or those without a college education should not enjoy the benefits of investing. Rather the problem is that the playing field with crypto as with all investing should be fair and transparent.
What Happens to Crypto When It Is Regulated
One use of crypto is to hide money or transfer money for nefarious purposes. If effective crypto regulation makes those uses more difficult we would expect to see crypto fall in value. If regulatory agencies clamp down on pump and dump schemes within crypto we would expect to see a less volatile market. If regulation results in more transparency and a more-level playing field, we would expect fewer investors would get hurt than in the current cryptocurrency setup.
Who Gets Hurt in the Next Bitcoin Crash? – Slideshare Version
Who Gets Hurt in the Next Bitcoin Crash? – DOC