You are misinformed. The people who provide the dollars to this market are the customers of the exchanges. It seems like you are not familiar with how a currency exchange works.
A currency exchange does not buy or sell the currencies traded at the exchange. All it does is match buyers with sellers, like an auction house. Buyers must deposit all the dollars that they use to buy before buying, and sellers must deposit all the bitcoins they sell before selling. When someone withdraws dollars after selling, the exchange simply transfers to them the dollars that the buyer deposited earlier. It already has the dollars on hand and does not need to borrow them from a bank, ever.
Now, not all places you can sell Bitcoin for dollars are currency exchanges. There are also brokers that do trade directly with their customers, rather than matching customers together to trade. In fact, Coinbase provides this service. However, they can simply obtain dollars by trading at currency exchanges themselves, and they adjust the price they offer to match the exchange price (plus a fee) so they can't just run out of money. Again, there is no need to borrow dollars from a bank. Furthermore, trading volumes at true currency exchanges absolutely dwarf the volume of any Bitcoin broker.
All that said, nothing prevents a crash in the Bitcoin price. If too many people want to sell and not enough want to buy, the price will go down a lot. But this is true in any market, and it has nothing at all to do with bank lending. Not even a little bit.
I fear you're misinformed. Besides localBitcoins, how does one get fiat to an exchange?
That's right — a bank. Exchanges like Bitfinex only survive because of things like Tether, which requires other fiat accepting exchanges.
If all exchanges were like Bitfinex, there would be a liquidity crunch, as the OP is saying.
When banks refuse to deal with an exchange like Bitfinex, it has nothing to do with liquidity concerns. It's because banks are required by law to verify who they are transferring money to (AML/KYC), and they don't believe Bitfinex abides by those laws (they are right).
BTW, Bitfinex recently reopened bank deposits and withdrawals.
Although that would be incorrect, there still are valid fears for a liquidity crunch, as I stated. This, regardless of why (be it laws or fund availability) does create a concern due to liquidity.
> BTW, Bitfinex recently reopened bank deposits and withdrawals.
Clearly not true. Especially for U.S. customers: https://www.bitfinex.com/posts/227
Also, if the Fed barred any Bitcoin sales/buys with USD (however unlikely) almost all reputable bank would drop those as well, regardless of country. This has been discussed in detail on r/BitcoinMarkets, actually.
I deposit USD to an exchange...then use that USD to place a Bitcoin buy order. Then I sell some Bitcoin another buyer on the exchange, who was only able to make this transaction happen because they too deposited USD or fiat into their account.
I get the money, they get the Bitcoin. Who is getting screwed?
LocalBitcoins would become a seller or buyers only recourse, for U.S. customers anyway, which takes a lot of coordination/time, and essentially becomes an obvious form of money laundering.
This doesn't seem like a fundamental problem due to the structure of Bitcoin or exchanges.
Banks don't provide liquidity to Bitcoin exchanges. Exchanges don't borrow from banks. Exchanges don't trade with their money, or their users' money. Exchange users deposit money to exchanges, and exchanges dumbly execute orders specified by their users. That's it. For example BTC/USD bids on an exchange's order book are 100% backed up by dollars that have already been deposited by users on this exchange's bank account.
In a closed system:
Day 1: $1 buys 1000 Marmotcoin
Day 2: $1000 buys 1 Marmotcoin
Day 3: 1000 Marmotcoin attempts to sell for $1,000,000
That's what the initial phases of a liquidity shock will look like. I can almost guarantee you that retail operations all have bank liquidity facilities to deal with sudden upswings in withdrawal demand, otherwise they have to commit house money to cover it.
That's now how an exchange works.
For the price to be 1,000,000 USD for 1,000 BTC, there must exist buyers with 1,000,000 USD and sellers with 1,000 BTC with orders to trade at that price.
There's no "house money" since exchanges aren't casinos where the players bet against the house. Buyers and sellers are transacting with each other, matching buy orders with sell orders.
The exchange doesn't have to borrow the USD from a bank, the buyers bring the USD to the trade.
There is no "liquidity shock" unless the exchange steals or loses the buyers' USD. And that's a different argument.
For example. If I bought $1000 for 1 BTC from Coinbase on January 1st 2017 and try to exit that position on Jan 1 2018, once I sell that $10,000 bitcoin to Coinbase I'll be withdrawing $9000 more than I put in. Coinbase has to get the $9000 from somewhere, whether that be from other deposits which are more recent than mine, or from its own trading operations.
If you have a large number of people trying to withdraw a large number of dollars at the same time, your offramp could run out of dollars or, in the alternative, be required to (a) draw down a facility with a bank or (b) sell assets. In an environment where the asset price is falling rapidly it may not be able to avail itself of either option.
As occurred in 2008, with dire consequences.
You simply cannot sell it if there is no buyer to take it. You never 'sell' to coinbase -- this is a front for GDAX, their exchange. Every buy is taken from a seller on their market. The money is exchanged between you and their account, and they take fees.
yeah, from the person that just bought BTC for $10,000.
I place the sell order with my brokerage, and I get fiat USD deposited into my account. This is exactly how Bitcoin is exchanged.
Where exactly lies the fundamental liquidity problem for my brokerage/exchange?
Every dollar that a user withdraws from an exchange is a dollar that was (already!) deposited by another user.
Day 1: Alice buys 1,000 Bitcoin from Bob for 1 USD on a street corner
Day 2: Market price on the street corner is 1 Bitcoin for 1,000 USD
Day 3: Alice sells 1,000 Bitcoin to Charlie for 1,000,000 USD on a street corner
The street corner doesn't have to borrow 1,000,000 USD from a bank.
Charlie brings the USD to the trade.
In a panic, you need to flip this scenario on its head. Charlie is not going to show up and Diana, who got into Bitcoin in 2009 and hasn't done anything since, decides to take her profits on 1,000 BTC. So this system has $1,001 to meet $2,000,000 in deposit demand, assuming neither Alice nor Bob has withdrawn their USD and some Bitcoin hodlers pile in.
Particularly popular liquidity pools eg BitPesa or Coinbase may then be put under pressure to either cease operations, draw down liquidity facilities to buy BTC, or start selling their own assets in order meet demand of BTC holders who want to get out. Those are not good choices.
No one is saying a price crash isn't possible. But it won't be caused by some liquidity issue, it'll just be people selling off.
You're essentially saying that the exchange should artificially prop up the price of bitcoin with its own money during a panic.
You use strange language. Maybe the scenario you mean to describe is not about lack of deposits or lack of float, but is a classic panic sale (ie. order books not deep enough to absorb all asks). Yes, this could happen with Bitcoin, or basically any financial instrument: stocks, forex, etc.
As someone who has been trading bitcoins since 2010, I will retort that market depths have definitely been growing over time. I don't have precise data to show you, but for example GDAX's BTC/USD order book accounts for 1/20th of the worldwide BTC trading volume. Right now selling 3600 BTC on GDAX would net $30M and dip the price -20%. Assuming the same depth at other exchanges, this means traders could globally sell 72000 BTC at the same instant for $600 million and dip the price by only 20%. That's a pretty decent market depth.
If market depth grew proportionally to Bitcoin's price, it would mean that 7 years ago when Bitcoin was trading at $0.25 (1/36000th its current price: http://bitcoin.zorinaq.com/price/) then a sale of $16k worth of Bitcoins would have dipped the price by 20%. I don't know if we can find archives of MtGox's trading data from 2010, but I roughly remember selling blocks of 1000 BTC at a time on Mtgox for $0.70-1.00/BTC in February 2011 and each of my sale would dip the price by a few percents.
So my (vague) recollection seems to indicate I'm probably right that market depth increased proportionally to Bitcoin's price. Therefore Bitcoin would have been at an equal risk of a panic sale at any point in the last 7 years. And the fact there has never been a long-term panic sale is a testament to Bitcoin's resilience. The markets are deeper and are more resistant than you think.
A little less ego and a little bit more self-doubt would do you good since you can't even tell the difference between volume and frequency Preston.
This happened to the London interbank lending market during the week of 15 September 2008, when LIBOR jumped to 8% and the banks simply stopped providing loans to each other. The reason? Because they weren't sure the assets their counterparties (other banks) were sitting on were worth anything (resi mortgages) and they didn't want to find themselves an unsecured creditor.
Mortgages during the subprime crisis didn't fall in price so much as they were impossible to price. This made the credit risk of bank borrowers impossible to price. So funding headed for the doors.
Change up the parties a bit and the banks --> offramps, mortgages ---> Bitcoin, and liquidity --> fiat, as in 2008.
There is simply no way that, as Bitcoin goes parabolic, the on/offramps are prepared to handle a change in the weather which results in a huge influx of withdrawals unless their own bank balances rise significantly. My informed supposition is that most such entities should have high-cost liquidity facilities with commercial banks that can step in and address some of that withdrawal demand.
As then, a liquidity shock (availability of dollars) could break the system without needing a precipitous drop in the market price of Bitcoin.