Mt. Gox fails to navigate the HODLer prisoner’s dilemma

One of the funnier aspects of the bitcoin investor community is the widely accepted belief that one should “HODL” (a reference to a 2013 forum post in which a bitcoin trader misspelled “hold”) their bitcoin through the ups and downs of price fluctuations indefinitely. This idea never really made sense to me: on a long enough time horizon, every investment should, at some point, be sold to realize gains. But, in the case of bitcoin, I guess the idea is that if everyone buys, and everyone HODLs, but no one sells, then the price can only go up.

(New BTC does enter the market via mining, but only ~900 coins are mined per day, and that quantity will decrease over time as bitcoin approaches its maximum 21 million supply. There are currently 19.8 million outstanding bitcoin)

The issue with HODLing is that it introduces a prisoner’s dilemma: as long as no one sells, great, the price keeps going up! But if everyone buys and holds, bitcoin will grow increasingly illiquid, and one or two sizable sales could tank the entire market.

Now, I know what you’re thinking, you hear the phrase “crypto prisoner’s dilemma” and you think it must involve any of the many, many crypto CEOs that are currently serving a sentence as a guest of the government. Not quite. 

Last week, CNBC reported that 140,000 previously lost bitcoin were about to hit the market again after a decade-long bankruptcy involving a now-defunct crypto exchange has finally progressed:

Mt. Gox, the Japanese bitcoin exchange that collapsed into bankruptcy a decade ago after a major hack, is finally set to repay creditors, who are being rewarded handsomely for their patience.

Up to 950,000 bitcoin were lost in the 2011 hack, at a time when the cryptocurrency was trading for a tiny fraction of its current value. Some 140,000 of those coins were recovered, a haul that, at today’s prices, means that roughly $9 billion worth of bitcoin will be returned to its owners.

This, of course, led to bitcoin hitting its lowest price in five months, as my colleague Toby mentioned earlier today:

The original cryptocurrency is suffering a meltdown in price after long-defunct crypto exchange Mt Gox moved over 47,000 bitcoin (well over $2 billion) to start repaying its $9 billion debt to former customers. Following last night’s moves, bitcoin dipped below $55,000, a price it hasn’t touched since February.

A $9 billion payout may not sound that big, considering that bitcoin’s market capitalization is larger than $1 trillion, but bitcoin is an illiquid market. Daily trading volume for the crypto currency only surpassed $30 billion five times in June, compared to a sub-$20 billion volume eight times, meaning that $9 billion of new supply can absolutely impact its price. If you are a bitcoin HODLer, you now have to perform some mental calculus: will the creditors, who have waited a decade to receive their collective $9 billion, HODL? If you believe that many of them will instead look to sell, you might sell to front-run their potential selling, which would send bitcoin’s price lower, which might incentivize other HODLers to sell as well.

Considering that only “some” of the $9 billion bitcoin has so far been distributed to creditors, and trading volume in bitcoin yesterday hit $57 billion, its highest level in a month, it appears that some HODLers did, in fact, stop HODLing. Crypto really is game theory all the way down.