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Peter Kim Frank
Peter Kim Frank

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Is Bitcoin vulnerable to a "bank run"?

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?

Via Wikipedia:

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?

Discussion (19)

nske profile image
nske • Edited on

I think there will always be someone wiling to buy at some price and someone wiling to sell at some price. If there is a mass-panic sell, the exchange rate against fiat currencies will naturally collapse, up to the rate where supply and demand reach equilibrium. And the cycle will continue. The fact that Bitcoin does have characteristics that are useful is the only guarantee there will be people willing to buy at some price, but it is a good guarantee.

peter profile image
Peter Kim Frank Author

Thanks, I think this is a good way of describing it. I think I wrote this post at some level to push back against the "nothing can stop this run" optimism I've been seeing on Twitter and elsewhere.

As I've built a more nuanced view and spoken to more people, I'm finding general agreement that "Yes, like all things, it could drop mightily in a mass-panic sell, but... remember it has inherently useful and unique characteristics."

I just think people need to appreciate the specific dynamics which could exacerbate a panic and mass sell-off.

nske profile image
nske • Edited on

I agree and wish more of these people had watched some of Andreas Antonopoulos brilliant talks. That would hopefully give them some perspective about what bitcoin is about. Tempting as treating it like just an investment might be, it is unfortunate to not think about its real significance.

Here's one that I enjoyed a lot
(watching the 2nd half requires a registering to but I think is worth it)

Also I think the answers to some of the Canadian senators questions on the following are also illustrative

jesseditson profile image
Jesse Ditson

I see some issues in some of the comments, so hopefully I can make this clear:

  • A Bank Run happens when a bank becomes insolvent, e.g. it does not have physical assets to match the value it's customers have given it. Bitcoin however is a fixed, scarce, resource - and bitcoin itself cannot be "run" in the same way a bank can.

  • A more illustrative question might be "if everyone sells their bitcoin all at once, will I lose money if I also want to sell at that time" - which comes down to much more familiar financial dynamics - you can always sell for what the market is willing to pay. This value can drop as fast as it can rise, which we all know is very quickly. Can your bitcoin lose thousands of dollars of fiat value in a matter of minutes? Absolutely.

  • Another important thing to understand is that bitcoin is not itself currency - we primarily think of it in reference to fiat currencies, which have nothing to do with scarcity. Bitcoin is more comparable to gold when thinking about these types of scenarios. You cannot as of yet lend bitcoin, and exchanges receive and give no credit, nor is there a government willing to guarantee its value.

  • The last and likely most important thing to understand is that Exchanges do in fact re-introduce a bit of a bank-like paradigm to the market. If you bought through an exchange, you do not possess the assets, as they belong to private keys that you cannot directly access. Something that looks quite like a bank run is ABSOLUTELY POSSIBLE inside the conclave of an exchange. Gdax could crash, coinbase could become insolvent, the database could be hacked, and you will not be able to sell the assets you bought there. This is effectively the same as a bank run when it comes to fiat in your pocket.

There is a convenience and safety tradeoff when using an exchange - they are much less likely than you to lose your private key, they are much more safe/dependable than trading fiat assets for crypto assets in the traditional way (bringing a suitcase of money to a hotel), and they provide a sense of fairness when it comes to value, especially when it fluctuates so rapidly. But you should be aware that if a major exchange crashes, or if the value of BTC drops, large amounts of value stored in exchanges will be highly at risk.

On a personal note: please avoid thinking of BTC as an investment - it's relationship to fiat is incidental. If you want to gamble on high risk markets, the stock exchange is a wonderful place for that.

mindflavor profile image
Francesco Cogno

I think Jesse's comment is perfect. Allow me to elaborate further though:

A Bank Run happens when a bank becomes insolvent, e.g. it does not have physical assets to match the value it's customers have given it. Bitcoin however is a fixed, scarce, resource - and bitcoin itself cannot be "run" in the same way a bank can.

Most people think banks keep all your money somewhere to be readily available (ie in cash). It's simply not true. The bank can and will use your money to invest in enterprises. While invested that amount cannot be retrieved at will (it's called illiquid). Maybe the bank bought a warehouse. Or financed a startup. Whatever. But your money is no longer "cash".

Depending on regulations, banks are required to keep a minimum of liquid cash available (say, 10%), so as long as people do not withdraw cash over 10% of total assets everything is fine. But if people start withdrawing money massively (for example because of a crisis) the bank can simply run "out of cash".

With Bitcoin this cannot happen as the "currency" is always available in the ledger by definition.

peter profile image
Peter Kim Frank Author

Terrific answer. Thank you.

lpasqualis profile image
Lorenzo Pasqualis • Edited on

I think that Bitcoin is definitely at risk. What we are observing now is a crazy emotional increase of a price for something that has absolutely no value behind it. BitCoin is not a company that produces some great product; it is a crypto-currency, with no value proposition other than being a cool experiment. Historically, these kinds of things imploded suddenly.

It is amazing how much the price grew quickly, but you have to keep in mind that it could drop even faster. When it starts, it won't be a bank run, it will be a massive mob breaking down the doors and ripping the place to shreds to cash-in an inflated value.

peter profile image
Peter Kim Frank Author

I've been speaking with a number of folks over the last 24 hours. I've been surprised to learn about a number of instances where BitCoin (somewhat counter-intuitively) represented a safer store of value than a Fiat currency. Of course, this claim is only true in extreme scenarios where the local currency is highly unstable and/or corrupt.

It did open my eyes to the fact that there are legitimate actors benefiting from the distributed nature of Bitcoin, and the ability to temporarily store value in that asset.

jillesvangurp profile image
Jilles van Gurp

Obviously, because it has happened multiple times already. Bank runs destroy banks but bitcoin keeps on existing even if its value drops dramatically. So there's a difference. Also, you might have a hard time selling your bitcoin when the bubble bursts. Or rather, the people buying it will be those that believe it will recover, which it has done on all previous occasions. This is why it keeps recovering.

Ultimately the value of any currency is tied to the volume of the economic transactions conducted with it. This is not zero in bitcoin and other crypto currencies. Rather it is growing quite rapidly and projected to continue to grow. The more transactions are happening, the more valuable the currency.

You might ask the same questions about some real world currencies like the pound, euro, or dollar. The US government just announced it is going to print a trillion dollars (deficits == borrowing == printing money). That's one thing you can't do with bitcoin.

For the record, I don't own any bitcoin.

databasesponge profile image
MetaDave 🇪🇺

Everything that people now say about Bitcoin -- that there will always be a demand, that supply is inherently limited, that everything is worth whatever someone else is willing to pay, that it is independent of world governments -- applied equally to tulip bulbs in the early seventeenth century

carywreams profile image
Cary Reams

I might find another metaphor than "bank run." I associate a "bank run" with the difference between "cash on hand" and "deposits."

Maybe focus on the effects of scarcity (max 21M bitcoin) and emotion (fear of missing out) to proxy the psychology of bitcoin value.

Good luck.

peter profile image
Peter Kim Frank Author

Thanks, if I could go back in time, I would have honed in on the term "mass sell-off" or "panic crash" or something like that. "Bank Run" didn't really capture it properly.

dwd profile image
Dave Cridland

You're asking entirely the wrong audience. We're computer programmers here, not economists.

Luckily I'm one of those irritating generalists.

So things I can tell you that might help:

Bitcoin is not a bank, so cannot be susceptible to a "bank run", where the end-game is a bank unable to satisfy a withdrawal request.

Bitcoin is a currency (by some definitions) or a stock (by others). A stock run terminates when a company's stock value goes below its operational assets, so becomes cheaper to buy the entire company and sell the remainder than to operate it. Bitcoin has no assets, so you'd think this wouldn't work - but recall that a bitcoin's mining costs are measurable in terms of electricity etc, so in some ways its closer to a stock than a currency, where a state can (more or less) just print more. Bitcoin only survives as long as miners are incentivized to continue validating transactions - if the price of a bitcoin drops below the mining cost, the only remaining miners will be those incentivized externally (ie, those making money due to the transactions being verified, like people selling things only available with Bitcoin).

Although you might think it's a currency, it's actually going up so sharply today that its almost impossible to usefully use as one. It's hard to see any transaction beyond investment that would make it worthwhile. But when a run on a currency happens, the currency typically plateaus, and the state either devalues it, creates an entirely new currency (with an initial exchange rate to the old, and usually - but not always - drops the old currency), or (in some particularly bizarre cases) simply starts using some other, more stable currency. But all the end games require some kind of state action.

A run on a stock is possible, but generally operates where people lose faith in an operating company. A run on a currency is much the same. But here's the key thing - for really effective runs, you'd need a futures market. And as I write this right now, there isn't one for Bitcoin.

Futures markets operate by making what suits call "investments", and we call "gambling", based on the future value. The most well-known of these is a "short", or "short sell". This is [simplified] a bet that the value of the asset (here, bitcoin) will drop below a certain value by a certain time.

If lots of these are seen on the market, there's a strong suggestion that lots of investors feel the price will drop, and this will cool other investors buying for investment - and sure enough, the price drops.

More interestingly, there ends up being a tipping point where investors switch from investing in Bitcoin to investing in Bitcoin short sells.

This is, clearly, much more likely to happen if the asset is hyper-inflated. You know, like if it were growing exponentially. Especially if it were growing exponentially with no futures market to allow an expression of confidence that the price would drop. This is simply because the short sells can be much - much - more lucrative. Every cent a bitcoin is worth can be harvested back, sometimes a few times over, in crashing the currency, and the hyper-inflation of Bitcoin triggers the loss of confidence much more easily.

If a futures market for Bitcoin were to open just when the price is rocketing, and a bunch of savvy investors shorted bitcoin like crazy, that'd crash the currency/stock below the mining cost, and Bitcoin would simply die. After all, everyone knows there's a bubble here - it's just a question of looking for what will burst it.

Tomorrow, as I write this, in Sunday 10th December. In Chicago, a Futures market for bitcoin will open for business.

Just sayin'.

lpasqualis profile image
Lorenzo Pasqualis

It is falling as fast as it went up:

blent_levent_37a3136e1cc profile image
Bülent Levent


ugurcano profile image
Döviz Kurları

bitcoin link : bitcoin