Banking crisis shows why Bitcoin is needed more than ever

Banking crisis shows why Bitcoin is needed more than ever

First they ignore you, then they laugh at you, then they fight you. And then you win.

Just 15 years after the fallout from the global financial crisis inspired the creation of Bitcoin, a new but eerily familiar crisis in the traditional banking world reminds us that the financial system is more fragile than many would like to believe.

The introduction of Bitcoin is shrouded in mystery – thanks in part to the anonymity of its creator Satoshi Nakamoto – but its creation was a logical response to the events of the 2008 financial crisis. What we know: The first appearance of Bitcoin came just two months after Lehman Brothers filed for bankruptcy .

The failure of major financial institutions, from investment banks such as Bear Stearns and Lehman Brothers to main street banks such as Washington Mutual, shook public faith in the banking system. This loss of trust led to the use of Bitcoin, creating the first decentralized peer-to-peer financial system, eliminating the need to rely on third parties and intermediaries. This was a revolutionary development that allowed people to “be their own bank” and put individuals on a level playing field with banks for the first time. Instead of being asked to trust a centralized intermediary like a bank with their money, Bitcoin was trustless and instead allowed people to verify in open source code.

Between the Great Financial Crisis and the current banking crisis, Bitcoin also served as a safety valve during the Cyprus banking crisis of 2013, which spread uncertainty across Europe. This turmoil led European citizens to diversify away from euros and Russian rubles into Bitcoin, driving Bitcoin from US$93 to a then-high of US$265 in two months and making many people who were simply worried about the safety of their savings to early adopters of Bitcoin. Noting that the Cyprus crisis predated the current debacle by exactly a decade, market maker Cumberland tweeted: “Ten years ago this week there was a bank run in Cyprus where ATMs were emptied and vaults depleted. This event triggered the biggest rally (percentage) ever in BTC… This weekend, ETH and other cryptoassets joined BTC’s strong performance in the face of banking turmoil. History doesn’t always repeat itself, but it often rhymes.”

Since then, Bitcoin has grown from an idea on a mailing list to a value of US$500 billion used by millions of people worldwide for a variety of purposes. Bitcoin and the cryptocurrency asset class it helped create have come a long way. But recent events show that the majority of people still have a long way to go when it comes to protecting themselves against the risks posed by today’s financial system.

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What happened?/Death spiral/Self-fulfilling prophecy

In early March, traditional markets were rattled by the news that Silicon Valley Bank had collapsed. SVB was the sixteenth largest bank in the United States with over $200 billion in assets as of December 31, 2022, making this the second largest bank failure in US history and the largest since the collapse of Washington Mutual in 2008.

Rumors of trouble began to circulate late on Wednesday March 8 when SVB’s chief executive said the bank would “rebalance” its balance sheet by selling treasuries and raising new equity in the company. This, combined with a downgrade of the bank’s debt by the rating agency Moody’s, caused what can best be described as a death spiral or self-fulfilling prophecy. According to the Wall Street Journal, on Thursday, March 9, panicked customers attempted to withdraw $42 billion, leaving the bank with a negative cash balance of $1 billion, leaving the bank unable to cover its outgoing payments to the Federal Reserve. Shares of SVB’s stock fell 60% that day, leading to more panic and more withdrawals as some venture capitalists urged their portfolio companies to pull their money from the bank. By Friday 10 By March, regulators had shut down the California-based bank and the Federal Deposit Insurance Company had taken over.

How did this happen? The tech-focused bank served many startups and VCs in the tech and biotech sectors, putting an outsized focus on these types of businesses. It saw a huge influx of capital during the years surrounding Covid-19 and the influx of financial liquidity that came with it. The bank invested much of this capital in US government bonds and other safe instruments such as mortgage-backed securities. However, the Federal Reserve’s fast and furious rate hike rate hit Silicon Valley Bank in two ways. The rising interest rate environment hurt technology companies, and many of Silicon Valley Bank’s clients had to withdraw significant amounts of funds. Secondly, it reduced the value of SVB’s bond portfolio, which was invested at a lower rate. New investment in technology and startups slowed due to the tighter economic conditions, meaning new money didn’t come in quickly. SVB was forced to sell bonds before maturity at a loss to meet liquidity requirements.

The fall of a large and established bank is startling both for its size and the speed with which it happened. The fragility of a large, respected US bank with over $200 billion in assets should give everyone pause. Although there do not appear to be any allegations of wrongdoing at this time, there appear to have been poor risk management practices. At the very least, the Department of Justice and the Securities and Exchange Commission are investigating the circumstances surrounding the bank’s collapse. Alfonso Peccatiello of The Macro Compass explains that with a bond portfolio of USD 120 billion and an average duration of 5.6 years, every 10 bps that interest rates rose caused SVB to lose USD 700 million, and a 200 bps increase would cost USD 14 billion, essentially wiping out the bank’s entire capital.

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Many startups and venture-backed firms expressed concern that they would not be able to receive their salaries the following week, and Y Combinator CEO Garry Tan described SVB’s collapse as an “extinction-level event” for the startup ecosystem.

Single point of error

That such a large and reputable bank could enter a death spiral like this at breakneck speed is a reminder of the importance of diversification – and the risk of being at the mercy of a single point of failure. As one customer told the Wall Street Journal, “We’re in a whole lot of trouble now. . . . we shouldn’t have had all our eggs in one basket.”

While banks like SVB have FDIC insurance, it only insures up to $250,000 per customer, which is insufficient coverage for most businesses or high net worth individuals. This collapse will therefore cause many to reconsider keeping all their assets in one bank. A customer with USD 1 million might consider dividing this sum between four different banks.

This is a useful starting point. Beyond diversification among banks, individuals may begin to consider diversifying into financial institutions in other countries, as well as diversifying into other currencies and asset classes, including Bitcoin and other cryptocurrencies.

Part of the appeal of a truly decentralized asset like Bitcoin is that there is no “Bitcoin CEO” – no management team making judgments of interest that could put the entire network at risk. As mentioned above, users do not have to decide whether to trust a company or management team to allocate against Bitcoin, they can instead verify (directly or by proxy) the open source code that governs the Bitcoin network. Additionally, anyone can see every transaction ever made on the Bitcoin blockchain, giving the network incredible transparency. Cathie Wood, founder and CIO of Ark Invest, pointed out that the current banking crisis would not have been possible in “the decentralized, transparent, auditable and over-secured crypto-asset ecosystem.”

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Is Bitcoin one of the winners amid the current banking turmoil? Many people seem to think so, and they vote with their wallets. Since the crisis first erupted on March 8, the price of Bitcoin has been strong. While Bitcoin initially briefly fell below $20,000 on March 9 amid the broader market panic, it has since rallied to above $28,000, for a gain of around 40% in just under two weeks at a time when the broader financial market is nervously.

Bitcoin is now up nearly 70% year-to-date, barely a quarter of the way into 2023, outpacing the gains of the S&P 500 and Nasdaq, which are up 3.8% and 13.8% year-to-date, respectively. Nik Bhatia and Joe Consorti of the Bitcoin Layer newsletter write that “The [Federal Reserve’s] aggressive interest rate hikes and balance sheet reductions have caused a historic banking failure – and developed a real-time advertisement for bitcoin self-storage.” Market maker Cumberland tweeted that “When traders are uncertain about crypto prices, they flee to stables and bank deposits. When they are uncertain about stables and bank deposits? It’s crypto’s time to shineand BTC and ETH rose 14% and 15% respectively over the weekend amid uncertainty in the banking sector.

Beyond the violence of the current crisis, remember that wherever someone keeps their dollars, they are at the moment lose 8% of their value on an annual basis due to inflation. With a maximum supply of 21 million and a money supply that is deflationary over time rather than inflationary, Bitcoin stands out in the current environment where central banks in the US and around the world are printing more fiat currency than ever before.

Ultimately, the problems of the traditional, centralized financial system led to the Great Financial Crisis and catalyzed the rise of Bitcoin. Fifteen years later, the old system is plagued by the exact same problems while Bitcoin has expanded in both value and capacity, making it clear that Bitcoin is as necessary now as it has ever been.

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