Here's What Might Happen If Bitcoin Crashes

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Includes: AMD, LGOAX, LMCJX, MGIC, NCMI, NEWM, NVDA, OSTK, SQ
by: John DeFeo

Summary

Bitcoin's price is skyrocketing because of high demand and low supply.

Prices can keep climbing as long as there are more buyers than sellers.

A selloff will threaten other markets if the cryptocurrency keeps growing.

I am not rooting for Bitcoin to fail and I am not predicting an imminent crash in Bitcoin's value. It's clear that more people want to buy Bitcoins than sell them right now; that will drive prices higher (look at the ratio of buy vs. sell searches in Google Trends.) But as Bitcoin's total value grows, I believe the risk of a selloff increases -- and that risk may spread to other markets. Here are some hypothetical scenarios that might create buying opportunities or inspire defensive posturing.

Is Bitcoin Doomed to Crash?

I think Bitcoin's price will fall sharply one day, but that doesn't mean the cryptocurrency is doomed to fail. The U.S. stock market fell by 90% and bounced back stronger than before. Bitcoin may be just as resilient: Its a global currency that has a purpose beyond speculation. Someone living under an oppressive government may have good reason to transfer his or her assets into a portable format. (Gold once served this purpose, but it's size and weight made it impractical.) Cryptocurrencies may follow the same boom, bust, and gradual adoption cycle that so many new technologies did in their early years.

Will the Stock Market Crash If Bitcoin Crashes?

I don't think a sharp drop in Bitcoin's price will crash the U.S. stock market, but I do think that some stocks will follow Bitcoin downward. Computer hardware companies, like Nvidia (NVDA) and Advanced Micro Devices (AMD), are vulnerable. These companies make graphics processing units that are in high demand among cryptocurrency "miners" (i.e. the people who use their computers to unlock fractional parts of encrypted digital currencies). A sudden sell-off in Bitcoin may cause a knee-jerk reaction that drags these companies down, even though the market has already realized that the good times won't last forever.

Similarly, the stocks of companies like Overstock.com (OSTK) and Square (SQ) are now correlated with Bitcoin. Overstock.com stock is trading 278% higher than its 52-week low price, largely because the company announced plans for its own cryptocurrency offering. Meanwhile, Square stock is up more than 200% from its 52-week low, because the payment platform is testing the ability to buy and sell digital currency within its app. What cryptocurrencies have giveth these stocks, cryptocurrencies can taketh back.

I'd also watch the stocks that Bill Miller owns, especially stocks with small market capitalizations. Miller's MVP 1 hedge fund is crushing the stock market this year because of his Bitcoin holdings. But if Bitcoin falters and his investors run for the exits, Miller may have to sell stocks to raise money for those redemptions. The stocks of huge companies, like Amazon (AMZN), can withstand selling pressure from a single, large investor; however, a smaller company may fall victim to that kind of selling pressure.

MVP 1 is a hedge fund so its stock holdings aren't publicly available like a mutual fund. Nevertheless, Bill Miller does manage two mutual funds: the Miller Income Fund (LMCJX) and Miller Opportunity Trust (LGOAX). In these funds, we can find small-cap stocks, like Magic Software (MGIC), National CineMedia (NCMI) and New Media Investment Group (NEWM). It stands to reason that Miller may also hold these companies in his hedge fund, so watch to see if trading volume increases during a Bitcoin selloff.

How Does Bitcoin Affect Gold Prices?

The gold market is about 41 times larger than the market for Bitcoin and, like cryptocurrencies, gold is an international commodity. This makes gold a difficult market to predict, although at first blush, it seems like Bitcoin has little power over the precious metal. I doubt that individuals who own gold are also interested in Bitcoin or vice-versa. The people I know who own Bitcoin are young and tech savvy. The people I know who own gold are older and generally distrusting of new technology. That's just an anecdotal observation, though. There is a common thread between both of these alternative currencies: distrust of the government. Bitcoin may seduce gold bugs as its price creeps higher and, if things go sideways, those same folks may return to the safety of their favorite precious metal. But, Bitcoin will have to grow much larger for us to see the impact of these actions.

How Big Can the Bubble Get?

Bitcoin's price can grow much, much higher. Few individuals and institutions own cryptocurrencies. If institutions make it easier for individuals to buy and sell Bitcoins (or parts of Bitcoins), demand will increase. And as long as supply remains tight, prices will skyrocket. I saw one Bitcoin owner quoted saying that he is waiting for Bitcoin to reach $192,000 before he sells. If every Bitcoin investor was like him, it could actually happen because the supply of Bitcoins will remain low. That price would also mean that Bitcoin, in total, would be worth $3.2 trillion. It would take credit, Bitcoin-based derivatives and lots of speculative amateurs for that to happen. But if it did, a Bitcoin crash at that size would threaten the world economy. Governments will almost certainly intervene before that happens.

Be Fearful When Others Are Greedy

I know Bitcoin owners who've earned a lifetime's worth of capital gains in a few short years and they still aren't satisfied; I wonder if they ever will be. Bitcoin has created millionaires and it took guts for these people to grow rich. They may grow richer still, but their fortune can disappear overnight. (Sometimes it takes guts to sell, too.) Cryptocurrencies may be the future, but rather than hold millions in any currency, I'd prefer to invest in boring dividend growth stocks and collect a check for the rest of my life. Now that excites me.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.