Getting to know the Bitcoin Market
Given that Bitcoin market is relatively new, investors share uncertainty about its long-term viability. Like other currencies, Bitcoin is susceptible to fluctuations in price and value. However, the mechanisms that govern Bitcoin are radically different than those of traditional currencies. Bitcoin uses peer-to-peer technology, which is a selling point for people hedging their bets against centralized government. However, in the event of a systemic failure, such as a market collapse, there exists no central authority to respond. In a conventional capitalist system, such as the U.S., for example, the Federal Reserve can intervene in times of crisis with monetary policy. The question then becomes: how effective is Bitcoin in times of failure? Although there is no definitive answer to this question, by examining Bitcoin’s historical performance in times of crisis, investors can improve their understanding of the asset.
Three Bitcoin Crises
Three consequential crises of Bitcoin include the regulation of the central bank of China (December, 2013)¹, the collapse of Bitcoin exchange Mt Gox (February 2014)², and the security breach of Bitfinex (August 2016). Each of these events directly impacted the price of Bitcoin, pictured below.
Bitcoin is Risky
In examining each of these failures, investors should consider the recovery process and the probability that a crisis will repeat itself. The regulation of the central bank of China was an unusual event; many investors were forced to exit the market and the remaining pool of investors became increasingly aware of the potential for regulation. The resulting slide in value of Bitcoin reflects the shift in regulatory risk analysis. This shift demonstrates that changes in legislation are often unpredictable and can have severe implications for Bitcoin price. To date, the price has not recovered to its high of December 2013. However, despite regulatory burdens, China has resumed high levels of Bitcoin consumption.
The collapse of Bitcoin exchange Mt. Gox and security breach of exchange Bitfinex demonstrate the market risk of database failures. Importantly, each of these cases was a result of human error. The blockchain did not fail, which possibly contributed to value recovery. In considering the recovery periods of each of these events, Bitcoin price recovered to 100% of its value within three weeks of the Mt. Gox collapse³, and has recovered to 97.5% of its value within a week of the Bitfinex collapse³. Despite lacking a centralized system, in each of these cases, after an initial loss, Bitcoin retained much of its value.
- Library of Congress: Regulation of Bitcoin in Selected Jurisdictions
- CoinDesk: Mt Gox: The History of a Failed Bitcoin Exchange
- CCN.LA: China now Controls Bitcoin (and that’s just the Beginning)