Bitcoin came into existence in 2009 in part as a
response to fears about financial intermediation and banking
following the financial crisis of 2008.
Aggressive rate cuts from the Federal Reserve and other
central banks sparked fears, which proved unfounded, of high
inflation that would sharply devalue major currencies.
More recently, market liquidity generated by a low
interest rate environment made its way into bitcoin, some
It’s a testament to the ferocity of the recent rally in bitcoin
that Federal Reserve Chair Janet Yellen was asked about it
multiple times during her
last press conference as central bank chair.
She said bitcoin
a highly speculative asset” that “at this time plays a very
small role in the payment system.” The cryptocurrency “is
not a stable store of value, and it doesn’t constitute legal
tender,” Yellen said.
Yet for better or worse, the Federal Reserve has played an
important, two-part role in the emergence of the bitcoin
Bitcoin came into existence in January 2009, in part as a
response to fears — which proved unfounded with time — that
central banks’ aggressive response to the Great Recession of
2007-2009 would generate hyperinflation and a collapse of
In 2008, many of the world’s marquis financial firms either
went bankrupt or stood at the edge of bankruptcy until taxpayers
bailed them out. Lehman Brothers’ spectacular collapse in
September 2008 marked the height of Wall Street’s
“People were looking at what happened in 2007 and 2008 and
thinking, is there a better way? These financial intermediaries
turned out to be pretty risky they made terrible bets,”
said Martin Chorzempa, a digital payments expert and
research fellow at the Peterson Institute for International
Economics (where I used to work).
And more recently, some analysts say that the market
liquidity unleashed by the Fed’s prolonged policy of low interest
rates, which it has been gradually reversing with rate increases
since December 2015, has helped drive the latest leg of the
bitcoin rally, which has taken its price to
ever mounting records now close to $18,000.
‘It looks less like a currency every day’
For Chorzempa, the problem begins with calling bitcoin a
digital “currency” when it is fact anything but a stable store of
“It looks less like a currency every day because the price is
just skyrocketing like a speculative asset,” he told Business
Insider. “I look at this latest addition of margin and leverage
with great trepidation.”
The Fed’s low-interest-rate policies are aimed at stimulating
investment and spending in a weak economy, but there are fears
that some of the money makes its way to more speculative
“There’s so much capital flowing around,” Chorzempa said. “All
the institutional investors are drooling over the kind of returns
that you’re getting in bitcoin” even though very few understand
Chorzempa warned that a deep crash is very possible and could be
self-reinforcing, because the incentives for bitcoin mining
decline as the prospects for price gains decrease.
Another key concern for bitcoin holders is regulatory
scrutiny. Yellen discussed bitcoin more as a risk for illegal
activities than as a new paradigm that could lower the cost of
funding for firms, as bitcoin evangelists tend to preach.
“The Fed doesn’t really play any regulatory role with
respect to bitcoin other than assuring that banking organizations
that we do supervise are attentive, that they’re appropriately
managing any interactions they have with participants in that
market and appropriately monitoring anti-money laundering bank
secrecy act responsibilities that they have,” Yellen said.
Then, there’s the issue of liquidity
Imagine deciding that, hey, at $18,000, it’s time to cash
out. Not so fast. Turning bitcoin into cash can be difficult if
“People overestimate their ability to cash out. If you have a
million bucks in bitcoin trying to do it in an exchange you’re
going to crash the price,” Chorzempa said. “So you’d need to go
to an old fashioned broker, do an over-the-counter negotiation.
“The hardcore people who have a lot will do ‘cold storage’ — a
USB drive, or write the code down on a sheet of paper and store
it in a bunker in Switzerland,” he said.
Chorzempa does not believe a bitcoin crash would pose a threat to
the financial system right now, but warned that steps to
legitimize its trading, such as the introduction of a futures
exchange, could ensnare more traditional banking institutions
that could generate systemic risks.
“Where the problems start to emerge is where it starts to build
links to the rest of the financial system. Futures build that
link,” he said.
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