Why the US debt crisis didn't affect bitcoin

Well, that was close. US Congress pulled the US back from the brink of a currency default last night – at least, for a little while. After over two weeks of battling between Republicans and Democrats, which saw a public sector shutdown, it finally passed a bill that would enable the government to reopen and pay its bills, just hours before the critical deadline. But if the US had gone over the edge, what could it have meant for bitcoiners? And if it happens again in a few months, what should we expect?

Another round of political chest-puffing isn't out of the question. This latest spat started when right wing tea party members refused to fund the US government unless it agreed to eviscerate the Affordable Health Care Act (nicknamed 'Obamacare'). The stand-off took the country to the brink of economic disaster, as the government grew close to the point where a lack of funds would prevent it from paying its bills. This would represent a default on US currency.

Some say that would be catastrophic, others slightly less so. This is because there are two types of default. There are cosmetic ones, where the US technically runs out of money but moves things behind the curtain, like Oz the Great and Powerful, to satisfy foreign debt holders. It could prioritize foreign debts over internal spending, sacrificing social programs, although this would not come without consequences. Heavily-armed populations without food stamps are a bad thing.

In any case, the US couldn’t keep that up forever. Eventually, the US would have to stop paying its bills, for real. “If there's an actual [not cosmetic] default, the world has bigger things to worry about than bitcoin,” says Jon Matonis, executive director of the Bitcoin Foundation and a contributing editor at CoinDesk. “Safety and food would be larger concerns,” he added.

All this is still worrying, because we’re not out of the woods yet. Bill HR 2775, passed by the Senate and a grudging House last night, only maintains spending limits until mid-January, and extends the federal borrowing limit until 7th February. It delays, rather than solves, the problem. Both sides have to keep talking, and experience suggests that they’re not particularly good at it. Republicans have already said that they’ll continue fighting Obama’s healthcare bill. So it’s possible that we could end up here again well before the spring. It’s happened before, in 2011, when partisan squabbles threatened the government’s ability to pay its debts.

Normally when a world economic crisis hits, people flee to the US dollar. It happened in 2008, even though the US was largely the cause of the financial problem.

Even then, the US dollar was seen as a safe bet. But if the country caused an economic crisis by defaulting on its own currency, the dollar would be seen as less trustworthy. So if this problem comes around again in a few months, will people flee to bitcoin as an alternative?

Probably not, says Kevin Zhou, head economist at Buttercoin, which sells a software engine for bitcoin exchanges. Even most fund managers aren’t that clued up about the cryptocurrency, argues Zhou, who handled quantitative research at Standard & Poors and post-trade analysis at Cutler Group before taking a role at Buttercoin. Even fewer individual investors will be bitcoin-savvy. Zhou said:

In any case, bitcoin is still a risky asset compared to gold. “Bitcoin, while it shares numerous properties with gold, is still missing one – that of history and long-standing performance,” says bitcoin expert and entrepreneur Erik Voorhees, who sold SatoshiDice for almost $12m earlier in the year. “It is still new, exotic, volatile, and highly speculative.”

Roger Ver, president of bitcoinstore.com and a member of the BitAngels investment team, doesn’t think that bitcoin would be massively affected by a US default. “I don't think this would have an immediate short-term impact,” he told CoinDesk. “It would be one more example of why we need the separation of money and State that bitcoin represents.”

Lack of knowledge is one reason why bitcoin might not be hit hard by a US default. The other is a lack of size. As of last night, bitcoin’s entire market capitalization would pay for just under four hours interest on the massive US debt. Bitcoin is very important to its advocates, but largely irrelevant to the majority of investors.

Someone watching the pricing charts over the last few weeks might wonder if the threat of a default hadn't pushed prices higher, though. The market crashed for a short period when Silk Road was taken down, but quickly rebounded, and is now in rude health. As of last night, prices were higher than they have been since May, when bitcoin ended a particularly volatile month, having spiked above $140 on several occasions over the prior month.

October’s recovery and soaring prices happened during exactly the same window as the shutdown crisis. But Ver puts this down to added media attention, while Voorhees attributes it to a mixture of increased confidence following the quick Silk Road recovery, and the Baidu announcement this week.

In any case, says Ver, “there will never be an actual default. They will print more dollars to pay the debt, causing massive inflation”.

Not that this is particularly preferable. Ongoing borrowing caused by untrammelled spending is a grim alternative to a default, and it worries Jaron Lukasiewicz, CEO of bitcoin exchange Coinsetter, which comes out of beta next week and will be open to the general public. “It is a mathematical fact that our country will either need to default on its debt or experience a large amount of inflation," he says. “This unfortunate circumstance makes me passionate about bitcoin.”

He’s passionate because bitcoin isn’t inflationary. Like gold, it is limited – more so, in fact, as you can’t keep finding new bitcoins and pulling them out of the ground. Neither can you simply keep printing as many as you need, as the federal reserve does with US dollars. Once we’ve mined 21 million bitcoins, that’s it.

Bitcoin’s deflationary characteristics may not make it unique, but its decentralized nature does. “One of the reasons that bitcoin is touted as a way to preserve your capital and retain value is that it isn’t just centrally controlled, and so it can’t be freely printed and debased,” says Zhou.

Jonathan Silverman, head of trading at currently-benched exchange Tradehill, doesn’t even like comparing bitcoin to other assets. He argues that every year it has existed, bitcoin’s value has accumulated no less than 400%.

Silverman, a former trader at Morgan Stanley, who moved to Tradehill after wanting to explore the digital currency space, said:

The cryptocurrency cannot be controlled by a small cadre of politically-motivated people, willing to bring a government to its knees over an ideological issue. And while bitcoin may still be considered a marginal, risky currency, it is getting stronger. Bitcoin came from shaky beginnings, with exchanges that disappeared almost half of the time, often taking their customers’ coins with them, but things are changing.

The cryptocurrency now has a stronger exchange infrastructure, and a clearer path forward from a regulatory perspective in a number of developed economies, says Silverman. It also gained interest from people with deeper pockets, such as the Winklevii, and SecondMarket. And then, there are the merchants that are making it more tractable everywhere. “Bitcoin is scarce, and it’s becoming more useful, which makes it more valuable,” says Silverman.

So, while bitcoin is volatile, its relative indifference to the machinations of the US political system tells us something. Its fundamental differences to fiat currency, along with its gradually increasing maturity, are helping to shield it from short-term market shocks such as the one surrounding the debt crisis. Or, as Ver tweeted yesterday, bitcoin just might be the “honey badger of money”.

Honey badgers are relentless hardasses, with no natural predators. They’re small, but fear nothing. Bitcoin seems to have fit the description in the last two weeks, as it ate the USD’s lunch. So, amid the uncertainty, panic, and strife, should bitcoin exchanges be happy?

“Bitcoin exchanges don't have time to be happy,” says Voorhees. “They should brace themselves ... and probably upgrade some servers.”