The Economist: What would happen if the price of Bitcoin went to zero?

On August 5, the website of the British weekly The Economist published an article titled "Disaster Scenario: What Would Happen If the Price of Bitcoin Went to Zero?" The full text is excerpted as follows:

A year ago, there were about 6,000 virtual currencies listed on the cryptocurrency market cap website. Today, that number has grown to 11,145. The total market value of these virtual currencies has also swelled from $330 billion to $1.6 trillion today.

Despite the astonishingly fast expansion, the virtual currency market's nature of ups and downs has not changed at all. The price of Bitcoin fell from $64,000 in April this year to $30,000 in May. Currently, the price of Bitcoin is hovering around $40,000.

Every drop raises the question: How severe could the negative impact be? If the virtual currency collapses completely, it would hurt too many people.

However, to gain more insight into the growing connection between virtual currencies and mainstream markets, we can assume that the price of Bitcoin completely disappears.

If a market crash occurs, the cause could be a shock from within the system, such as a technical glitch or a major cryptocurrency exchange being hacked, or it could be external, such as a regulatory clampdown or the current financial market “everything goes up” trend suddenly ending due to factors such as a central bank rate hike.

A crash would devastate the cryptocurrency economy. Bitcoin miners would have little incentive to keep mining, bringing the supply of bitcoin to a standstill. Investors might also sell other cryptocurrencies.

The result is a massive amount of wealth being destroyed. The biggest losers will be those participants who bought Bitcoin less than a year ago and at an average purchase price of more than $37,000. This will include most institutional investors with Bitcoin exposure, including hedge funds, university endowments, mutual funds, and some companies.

The total amount of wealth wiped out would exceed the total market value of digital assets. The crash would also wipe out private investment in virtual currency companies such as exchanges (estimated to be $37 billion so far) and the wealth of publicly traded virtual currency companies (valued at around $90 billion).

The subsequent impact of the collapse will also spread to other asset markets through various channels, and neither virtual currencies nor mainstream currencies will be immune. One of the channels is leverage.

In addition to the actual sell-offs that would result from a collapse in the cryptocurrency market, there would be widespread psychological and emotional impacts. The extent of this impact remains unknown: while more and more entities now have exposure to cryptocurrencies, in most cases this represents only a small portion of their wealth, so losses are likely to be widespread but limited.

The key is that the banking industry is immune to it, and most banks are unlikely to have Bitcoin on their balance sheets anytime soon.

But it’s not hard to imagine something worse. Low interest rates cause investors to take more risk. A virtual currency crash could cause them to start abandoning other toxic assets. In recent months, the correlation between Bitcoin prices and even the broader stock market has been increasing.

Of course, a lot of things would have to go wrong at once for the entire market to go haywire, including the price of Bitcoin falling all the way to zero. But our extreme scenario research shows that leverage, stablecoins, and psychology are three main channels through which a drop in the cryptocurrency market (no matter how big or small) could have broader impacts.

In addition, virtual currencies are becoming increasingly inseparable from traditional finance. Goldman Sachs plans to launch a virtual currency exchange-traded fund, and Visa now offers a debit card that pays customers in Bitcoin. As virtual currencies continue to expand, their potential to cause major disruption to the market also continues to grow.

(Original title: British media article: What would happen if the price of Bitcoin went to zero?)