Depending on who you ask, the Bitcoin bubble either popped over the holiday weekend, or there was a panic that the market has since recovered from, nothing to see here, move along. Either could be true, in the long term, but the reality of Bitcoin means that panics will simply be a way of life.
- First, let’s talk financial panics: Financial panics are simple, really. Enough people freak out over an event and withdraw their money from an asset or an institution so quickly that the situation snowballs. A good example is a bank run; if people think a bank is failing, they take their cash out. But banks make money by investing the cash you deposit with them, so they don’t have enough cash on hand to cover a huge number of deposits being yanked all at once. Thus, if enough cash leaves the bank, the bank collapses. Financial institutions usually solve this by refusing to open the doors, which is exactly what Coinbase did last Friday.
- Your US dollars have certain protections, thanks to bank runs and other disasters: Thanks to bank runs destroying banks (and leaving people without their savings), the US government instituted certain ideas like forcing banks to keep a certain percentage of their assets on hand at all times and insuring your deposits up to a certain amount. Ever wonder what the FDIC sticker is in your bank’s window? It’s the Federal Deposit Insurance Corporation; just like your car, your home, and your health, your money is insured.
- Bitcoin, by design, does not have those protections: It’s easy to forget amid the hype that Bitcoin, in particular, is an experiment by an anonymous libertarian designed to see what happens when you create a currency untethered from any centralized authority (including law enforcement) and instead basically crowdsource everything. So, right from the start, Bitcoin has been heist-prone and absurdly volatile.
- Remember, Bitcoin is backed by nothing but the faith of investors in Bitcoin: Again, this is by design. Bitcoin is tied entirely to the free market, and the free market is inherently absurd and volatile. The free market does weird, irrational things all the time, so basically, Bitcoin is a fiscal roller coaster and nobody’s got a handle on the brakes. When you invest in Bitcoin, or any cryptocurrency that isn’t backed by something, that’s what you’re signing up for.
In other words, whenever a panic ends, a new panic is coming. Eventually, Bitcoin will stabilize, if more and more people use it (a broader base of people treating a currency like… currency is a naturally stabilizing force). For now, expect swings. Advocates will, and fairly, point to the overall trend which, for the moment, is going up. But the same was true of the housing market, the dot-com boom, and a host of other financial bubbles. Investing is always going to have at least a little anxiety attached, but for Bitcoin, it’s worth remembering that anxiety is built into its very code.