Many fear that vested interests may artificially suppress the price of bitcoin in the same way gold prices have historically been artificially suppressed by those same interests.
However, experts who I follow, including the brilliant Caitlin Long, think such fears are overblown. Unlike gold, bitcoin prices cannot be suppressed indefinitely via futures, options, and other forms of "paper bitcoin" (that is, IOUs for bitcoin rather than actual bitcoin), at least not without the suppressor taking on existential risk. This is true even if the suppressor is a central bank or a nation state, and it should remain true for so long as bitcoin custody remains sufficiently decentralized.
Why is that so?
For two reasons. First, unlike gold (where taking physical delivery of large amounts is cumbersome, costly and somewhat risky), any reasonably responsible person or entity can safely and cheaply take physical possession of unlimited quantities of bitcoin, and a great many of them do.
That matters because, as we will see, any would-be bitcoin suppressor must always be prepared to deliver actual bitcoins to its counterparty on demand at a moment’s notice. Failure to deliver in-kind as contractually required could bankrupt the suppressor or otherwise cost it dearly.
And second, bitcoin’s supply is entirely inelastic, meaning that any increase in net demand will spike price much more quickly and significantly than with any other asset. For more on this subject, see my article titled “Bitcoin’s Perfect Scarcity and its Significance”.
How can would-be suppressors ensure that they are always prepared to deliver sufficient bitcoin to their counterparty in-kind and on-demand?
One way is to keep at least one bitcoin in reserves for every bitcoin it may ever be obliged to deliver under contract.
No new artificial “supply” is created when the suppressor takes a bitcoin off the market and holds it in reserves to back a newly issued claim to that same bitcoin. One bitcoin in and one bitcoin out does not change the count, does not create new “paper bitcoin,” and therefore does not help suppress the price.
So, to accomplish the objective of creating enough “paper bitcoin” to materially suppress prices, a suppressor must instead operate on a fractional reserve. That is, it must create new “paper bitcoin” out of thin air by owing its counterparties far more bitcoin than it has on hand to cover its obligations (as is commonly done with gold).
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But as we’ve said, running on a fractional bitcoin reserve is a very risky thing to do since customers can force a “run on the bank” comparatively easily, cheaply, and safely by cashing in their IOUs en masse and demanding physical delivery of their promised bitcoin at any moment. Said another way, bitcoin whales can at anytime force a short squeeze (as recently happened with nickel). If enough of them do and the suppressor can’t deliver actual bitcoin, the suppressor is toast. Bankruptcy, massive losses or an complete loss of credibility await.
In the gold and silver worlds, this doesn’t happen because (1) almost nobody ever takes physical delivery of gold and silver due to cost and security considerations (not even most central banks and nation-states custody their own gold!), and (2) the large intermediary custodians that hold everyone else’s gold constantly bail each other out by lending their physical gold to each other in the rare instance where a large physical delivery is demanded and the suppressor doesn’t have enough of the physical asset on hand to cover the redemption.
In other words, if JP Morgan must deliver more physical gold than it has on hand, it can simply borrow enough gold from another large gold custodian to ensure that it doesn’t default on its obligation and bankrupt. This courtesy is generally granted as a matter of course.
Unlike with gold, there are no extensive, centralized intermediary holders of massive quantities of bitcoin (and likely never will be since it can be so easily and cheaply stored on one’s own) to borrow from. And any would be lender is going to be hesitant to loan under these circumstances for fear that they may be next to suffer a bank run. Said another way, when taking physical delivery is very easy, bank runs become very easy and therefore must be guarded against.
So what’s the suppressor to do? How can it deliver the bitcoin it owes?
Well, if it has insufficient supply to deliver on its obligations, it must attempt to acquire the requisite quantity of bitcoin immediately on the open market.
But what if the bank run is being caused by a bitcoin liquidity crisis (as would usually be the case)? In other words, what if everyone is racing to convert their bitcoin IOUs to actual bitcoin all at the same time (perhaps because the financial system is perceived as failing, or possibly because bitcoin has suddenly gone “no offer” for a period of a few hours or days on several exchanges)?
In that case, the suppressor can’t instantly acquire sufficient bitcoin on the open market to meet its delivery obligation. Or perhaps it can, but only at a price so high as to bankrupt it or at least cost it billions in overnight losses. After all, bitcoin’s perfect scarcity make such sudden and extreme spike hikes a very real possibility.
Yes, yes, some bank or exchange will be arrogant enough to try it. And as Caitlin Long has predicted, that attempt will almost certainly one day bring down a systemically important financial institution. After that, fractional reserve bitcoining is not something likely to be repeated by responsible parties and may well be banned.
Due to its nature, it enjoys greater immunity to the techniques “they” have long used to suppress the prices of gold, silver, and other commodities.
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