Bitcoin bubble

I wrote an article sometime ago about the virtual currency Bitcoins, so it would be useful to do an update. For bitcoin has recently been accused of exhibiting classic bubble like behaviour.

Having first seen its value fall, but its image cleaned up somewhat by governments cracking down on the use of Bitcoin by various criminals, notably on the website “silk road”, the value of Bitcoin has gone up rather a alot in recent months. However it took a tumble after the Chinese government more or less banned transactions in it, as they fear its been used for tax dodging and money laundering.

But getting back to this question, is it a bubble? Is comparing bitcoin to tulip mania (as Forbes magazine suggests) being fair? Well one could argue that a bubble is where people are buying a commodity not out of general need, but in the majority of cases, purely because they believe the price will rise in future.

At the start of tulip mania for example, people bought and paid a lot for tulips because tulips were considered a valuable commodity. But beyond a certain tipping point the majority of people had little to no interest in actually growing tulips, they were a means to an end.

Similarly in the lead up to the financial crisis while yes people need homes, many houses were being bought (often by people building up massive property portfolios secured purely on the back of previous house purchases) purely as part of speculation on the property price rising.

Obviously enough the danger is, as demonstrated by the sub-prime crisis (or the dot-com bubble), sooner or later supply and demand factors change or the market simply runs out of investors and the bubble bursts.

Now one can argue that there is a genuine need for people to buy bitcoins, as it might well be able to defy the convention (virtually all the other attempts at creating a virtual currency have failed) and become a viable alternative to government controlled currencies. However, one still has to question if the rapid rate of growth is justified.

While I’m not the biggest of internet shoppers I have to say I’ve never come across a website or a business in the real world that supports payments in bitcoin (I’m sure they exist, just not that many of them). Thus the actual transactions in bitcoins are, I would argue, probably fairly small, which would certainly imply a bubble and probably a market correction at some point in the future.

And there’s also exclusivity, something the currency lacks, as many competitors to Bitcoin have sprung up. The implication of this being, that it will likely prove difficult for any virtual currency to hold value long term and Bitcoin might not be the one (if any) that proves successful.

Of course the irony here is that what the libertarians most behind bitcoin have perhaps succeeded in proving exactly why we want a currency backed up by governments. Libertarians argue that the problem with government backed currency is the temptation for the state to meddle is all too great. And one need only look to QE in the US and UK for prove of this as the Federal Reserve and the Bank of England try printing money as a solution to they’re problems (when instead they should be raising taxes or cutting back on the luxuries…like nuclear weapons and aircraft carriers!).

However, if there’s anything worse it has to be a currency backed up by nothing. Put yourself in the shoes of a business, would you seriously want to handle all payments (e.g. too you’re staff, suppliers, etc.) and store your profits in a currency that fluctuates this wildly in value? One of the whole reasons corporations prefer the dollar, pound or euro is that despite it all, they tend to be stable currencies that don’t fluctuate significantly in value. Indeed, ironically enough the only way that bitcoin works is by pricing it relative to dollars or euros! In short its equivalent to proposing the Zimbabwe dollar as an alternative to the US dollar!

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3 thoughts on “Bitcoin bubble

  1. the interesting thing about bitcoin though is no central bank involement and limited supply.
    I agree i can’t buy anything in waitose yet with bitcoin!
    But i think there are vested interests who wish to destabalise bitcoin.

    What real value does paper or plastic money have anyway when they indulge in QE?
    It’s all a question of confidence and faith and they can change overnight!
    And when the next banking crisis looms remember you can’t eat paper or drink oil amidst the earthquakes ands floods….

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    • I think the problem is that some people are letting their scepticism of national currencies convince them of the viability of bitcoin.

      As someone with an account in euro’s and one in sterling I’ve seen QE depreciate the value of the sterling account by 20-25% since the start of the economic crisis v’s my euro account, despite everything the euro’s been thro. So I’m not exactly the morale officer for the bank of England!

      But that doesn’t automatically mean bitcoin is a good idea! It certainly doesn’t mean one is worth $1000. After all there’s nothing to stop someone setting up their own version of Bitcoin (and there’s been a number of contemporaries established already).

      And there are others who, while supportive of the idea, don’t think bitcoin is the correct format (too much of a paper trail!) and its possible that if a virtual currency does take off, it might not be bitcoin.

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