Is Bitcoin the Answer in a Financial Crisis?

When a financial storm hits, will bitcoin save you?

Bitcoin as an alternative in a financial crisis

Bitcoin might be a plaything to many – a fun way to experiment with digital cash, or perhaps to buy things online that you’d rather people didn’t know about. But others are seeing it as a serious haven in a financial storm.

Countries that are in the midst of a financial crisis often tighten the financial thumbscrews, imposing capital controls on their populations that stop them doing even basic things like taking cash out of the bank.

Could bitcoin be an alternative for people in those economies?

At the time of writing, the latest country facing a financial meltdown is Greece. The country joined the European Union in 2001, and has been one of the poorest regions in Europe since. In 2008, when the global financial crisis plunged countries into recession, Greece suffered heavily. It has racked up huge debts, and has spent the last few years being bailed out by the European Central Bank, among others.

Greece’s government has become increasingly irritable about the austere conditions imposed on it by its creditors, and in June 2015 (the time of writing), negotiations on the latest round of bailouts finally collapsed. The company entered a referendum to see if it would stay in the euro or simply exit altogether. In the meantime, the government tried to avoid a run on the banks – in which panicky consumers take out all of their money – by simply closing them for a week.

Leaving a Sinking Ship

If people lose faith in a currency, the typical reaction is to start using another one. Traditionally, money has simply flung to the most stable currency, which has typically been the dollar. But bitcoin has a couple of advantages over old-fashioned cash.

The first advantage is that it is not controlled by any central authority.

In countries where people are increasingly distrustful of how central banks and governments manage the economy, bitcoin may seem like a more sensible alternative.

The second is that bitcoin may be easier to obtain than other fiat currencies. It can be bought and sold via bitcoin exchanges online, but also in direct transactions via sites like LocalBitcoins.com.

Evidence suggests that during times of crisis, people are increasingly looking to bitcoin as a viable alternative to their own beleaguered currencies. As the Greek crisis unfolded, bitcoin exchanges reported a healthy bump in volume as people traded the cryptocurrency around the world. The lion's share of the increase came from customers in Greece.

The price of bitcoin also rose significantly as the Greece crisis deepened, lending further credence to the idea of bitcoin as a ‘panic’ currency.

A History of Panic Buying

Price spikes in bitcoin have correlated with financial crises before. In April 2013, when Cyprus was in the thick of its banking crisis, prices of the cryptocurrency reached record highs.

Other places imposing capital controls have also seen populations flee to bitcoin. Argentina is a case in point. The country’s government stopped its population buying US dollars after suffering its own financial crisis.

Reports suggest that Argentina has become a hotspot for bitcoin activity, as banks stagnate. Prices there were higher than in other countries.

Argentina has even become a leader in the Bitcoin Market Potential Index (BMPI), a report produced by experts at the London School of Economics, which shows economies in which bitcoin could gain the most traction.

People might like the idea of fleeing a sinking currency in favour of a digital one with no central control, but there are potential drawbacks. For one thing, the price of bitcoin is extremely volatile, and people sinking large amounts of money into it could find their net worth rising and falling like a ship on an ocean squall. If people in troubled economies begin using bitcoin as some kind of safe haven, they could find themselves in even more trouble than they were originally.

As with any form of highly speculative financial instrument, people shouldn’t invest more in bitcoin than they can afford to lose. The problem is that if they are afraid of losing everything anyway, people might decide that any port is better, in an economic storm.