Is Bitcoin vulnerable to a "bank run"?
Peter Kim Frank Dec 7 '17
Bitcoin this, Bitcoin that. As I write this post, Bitcoin has jumped several thousand dollars in the last few hours! Every other tweet on my timeline is about bitcoin. Long lost friends from high school are texting me with questions about whether they should "get in on the action."
This isn't a post about the long-term potential of cryptocurrencies, blockchain technology, distributed applications, etc.
I simply want to understand the following: is bitcoin particularly susceptible to a "bank run" / massive sell-off?
A bank run occurs when a large number of customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent... As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals.
Now, I fully understand that a "bank run" talks about centralized financial institution, and that the whole point of blockchain is that it's distributed. So, I recognize we're talking about a distributed exchange and not a standalone bank — and the dynamics might be totally different. I also appreciate that actors in a "bank run" are worried about insolvency, not "just" a collapse in value of their asset.
But is the theory that the bitcoin market will always self-correct because there will be a natural balancing act between willing buyers and sellers? Does that logic necessarily hold up in the case of a mass sell-off?
As I understand it, the current market features:
- a huge number of "dumb" investors (excited by the store of value, and not the underlying technology)
- a huge number of holders sitting on "paper gains" that they may wish to realize before it's too late
- due to the crazy volatility, the potential for "falling knife" reticence about buying during a massive drop
- lack of technical stability (uptime) on exchanges (Coinbase et. al.) during periods of massive traffic
To this layperson, it seems like the confluence of these factors could dramatically exacerbate the effects of a mass sell-off. Holders new and old want to cash out during a big drop, at least partially. Buyers don't want to counteract those effects, knowing that extreme volatility could mean it keeps dropping harder and longer. Supply begins outstripping demand, lowering prices. And the consumer-facing exchanges (Coinbase, et. al.) crumble under the technical load, exacerbating the anxieties of investors that they need to get out before it's too late.
I have no true understanding of cryptocurrencies or even traditional markets, so I might be totally off-base here.
Can anyone explain whether I'm on the right-track or if I'm just totally misunderstanding the moving pieces here?