Tuesday, December 3, 2013

And Yet Another Perspective on the Bitcoin Bubble

Yes, I am calling the Bitcoin price a bubble..... and why not. I would be curious to see what happens to the infrastructure after Bitcoin prices come back to Earth.

An excerpt from by Gonzola Lira. 

There’s just one teeny-weenie problem with bitcoins:

Bitcoins don’t serve any useful purpose.

(And just in case it needs to be formally articulated: Stroking nerdy egos is not a “useful purpose”.)

Money, by definition, is a medium of exchange. In and of itself, money is perfectly useless. It is useful to the degree that it helps exchange goods and services for other goods and services.

Hence my two key observations regarding bitcoins—which are my key objections to it as well:

  • There is currently no market where you can buy any mundane good or service exclusively and necessarily with bitcoins.
  • There is currently no market where you can sell any work or service that you provide, or for any good you wish to sell, exclusively and necessarily with bitcoin.

(Also, actually acquiring bitcoins is remarkably complex—and completely negates the supposed anonymity of bitcoin. Here’s a Reddit editor discussing how tough it was for him to get bitcoins, which is fairly typical of retail customers: A whole lot of hassles, and he still couldn’t buy any. And for all the talk of “bitcoin’s anonymity”, you need a whole truckload of verifiable documents making clear who you are in order to buy your first bitcoin. So the bitcoin-anonymity argument is a chimera.)

The failure to meet that condition—“buy or sell exclusively and necessarily with bitcoin”—is what makes bitcoin essentially useless. Some people are touting that you can buy airline tickets with bitcoin: Sure—but so what, last I checked, all airlines are still accepting U.S. dollars. When airlines beging accepting bitcoins exclusively and necessarily, well then . . . but that day won’t come.

The fact is, bitcoins did have an imminently practical application, a market that exclusively and necessarily required bitcoins in order to participate: Silk Road, the online illegal drug market. Before Silk Road was closed by the government, you could buy weed or smack with a bitcoin or two—which was not only great if you wanted to get high, but also allowed bitcoins to behave as a currency is meant to behave: As a medium of exchange.

But since the closure of Silk Road, bitcoins have no raison d’ĂȘtre. Bitcoins have become a good in and of themselves, not a medium of exchange. I would go so far as to argue that the very fact that so many bitcoins bought you so many ounces of hash or so many pills of X prevented the deflation of bitcoins—i.e., the speculative mania in bitcoins—that we have been seeing over the last couple of months. The closure of Silk Road freed bitcoins from its task of being a mechanism of exchange, and allowed it to become what it is today:


Right now, bitcoins are rising against the dollar so precipitously—or in other words, deflating so abruptly (see chart below)—or in still other words, there is such a speculative mania in bitcoins—that even if there was something you could exclusively and necessarily buy with a bitcoin, only a fool would actually spend one on that good or service. I mean it has actually gone up over 1,000% over the last month.

Bitcoin price and volume chart.
Click to enlarge.

Hence since there is nothing you can exclusively and necessarily buy with bitcoins, and since it is rising against all other currencies so radically, it pays to hoard bitcoins rather than to spend them—and thus they automatically become a speculative good.

In other words, again, tulips.

Accepting for the moment that bitcoins might become a de facto currency for some market or other, its deflationary behavior over the last few months is an excellent argument as to why currency deflation is such a bad thing to an economy, arguably worse than inflation: The currency is hoarded, on the expectation that goods and services will become cheaper over time, which they do because people don’t buy and thus sellers lower their prices—thus encouraging people with cash to not buy, the economy falling into a deflationary spiral.

Bitcoin is following a deflationary spiral to a “T” . . . except for the basic fact that there is nothing to buy in the bitcoin economy except other bitcoins.

That’s why bitcoins will crash: It’s a speculative mania, folks. Every buyer of bitcoins is expecting its value to rise. And consciously or not, every buyer expects that in the future, there will be someone willing to pay more dollars for the bitcoins they have than they themselves paid out for them.

Consciously or not, every bitcoin owner is waiting for the greater fool.

Once the market for bitcoin buyers realizes that there are no more fools—or that the last holders of bitcoins are the last fools of the market—the value of bitcoins against other currencies will crash just as swiftly as it has risen. Faster, even.

So here’s the bottom line:

—If you don’t have any bitcoins, don’t get any. It’s going to crash—the “when” of course being impossible to predict, but as inevitable as the collapse of any speculative bubble.

—If you currently have bitcoins, then follow Joseph P. Kennedy’s very wise advice: “Only a fool holds out for top dollars.” If you’ve made some money on the run-up in Bitcoins, take the profits and count yourself lucky. If the bubble continues to rise, so what, you made your money. Better to sell too early than too late.

Without Silk Road, bitcoins are nothing but tulips. And tulipmania ended in tears for some, laughter for others.

Be the one who’s laughing when it all crashes.

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