El-Erian Predicts Bitcoin Crash if Savvier Investors Sit Out Correction

While bitcoin's price has recovered and held almost half of what it lost last Friday, one commentator believes the bitcoin market has reached a crucial juncture.

After the markets saw an epic drop of 45 percent in bitcoin's price on Dec 22 — down to $10,800, taking nearly every other cryptocurrency down with it, the price has since rebounded somewhat. Meanwhile, the chief economic advisor of Allianz SE and former CEO of Pimco Mohamed El-Erian has asked whether or not this could be a make or break moment for the bitcoin market.

In his column on the Bloomberg View published on Dec. 26, El-Erian wrote:

"Either this sharp price correction will act as a catalyst for expanding what, until now, has been quite limited institutional involvement in this market — or it will become a stage in the deflation of a remarkable and historic asset bubble."

Previously, El-Erian has called bitcoin more of a commodity than a currency because its price has remained too unstable for people to use it as a medium of exchange. Without walking that back, he acknowledged major milestones for the bitcoin market this year: its dramatic price increase, the opening of futures markets and very limited government intervention (besides China's).

Nevertheless, he argues that bitcoin has an underlying weakness: in his words, those taking a long position are less sophisticated retail investors while those taking short positions are all the more experienced ones. Meanwhile, institutional investors have overwhelmingly sat out the market.

That said, some of that could change following a price drop, which can be a sign that unattractive irrational exuberance may be leaking out of a market. He writes:

"After bitcoin experienced one of the biggest roller-coaster weeks in its young history, the most important question facing it is whether the recent price correction will prove to be what market participants refer to as 'healthy.'"

To prove itself, bitcoin investors will need to become more diverse, with experienced investors joining the retail investors in long positions and institutional investors joining the market at all. The correction will also need to yield what El-Erian refers to as "market-deepening products," without further elaborating.

If it fails to grow in these ways, he writes that retail investors will face "a price appreciation and collapse that would rival even the biggest investment bubbles in history."

Crystal ball courtesy of Shutterstock.