Bitcoin: When a Bubble Becomes a Geiser

April 4th, 2013
in econ_news, syndication

Econintersect:  It has been only 12 days since GEI News first reported on the surging speculation in Bitcoins in an article entitles "Bitcoins and Tulips."  Refer to that bitcoinarticle for background and history of bitcoins and the relationship to tulips.

Early in the day Wednesday 03 April 2013 bitcoins were trading at $147.  That is a doubling of value in just 12 days since the last GEI News article and a more than 10-fold increase since January.  There is truly a tulip-mania sweeping the bitcoin world.  The parabolic surge in prices since the beginning of 2013 has coincided with a halving of the rate of growth of coins in circulation over the same time.  The two factors together indicate that there is hoarding of bitcoins rather than an increased use in exchanges for goods and services.

Follow up:

Click on graph for larger image.


Note: This graph shows only end of day prices and the intraday $30 drop and $10 recovery does not appear.

The hoarders could experience a panic reversal of mania if late day trading in bitcoins carries over into the coming days.  Wednesday afternoon the bitcoin fell in price by more than 20% ($30) in just a few hours.  That was a drop far greater that the 7% flash crash for U.S. stocks in May 2010.  Will bitcoins be coming out of the woodwork the rest of the week?  It is hard to tell:  After the sharp $30 drop the price regained $10 and seems to have stabilzed around $127-$130 12 hours after the "crash".

The sharp decline was associated with reports of denial of service attacks and a security breach and theft at Instawallet, a bitcoin storage and exchange facility.  Instawallet says it will remain closed until further notice while it recovers from the attack.

Felix Salmon has a great review of bitcoins.  Here is an excerpt:

Bitcoins were designed to be – and, in many ways, are – the perfect digital currency: they’re frictionless, anonymous, and cryptographically astonishingly secure. For anybody who’s ever suffered the incompetence of a bank, or bristled at the fees involved in just spending money, either domestically or abroad – that is to say, for all of us – the promise of bitcoin is the holy grail of payments. Especially since, to all intents and purposes, bitcoins are invisible to law enforcement and the taxman.

Those strengths are also weaknesses. No one wants to risk losing millions of dollars worth of currency overnight, just because they were outsmarted by some computer hacker.

Still, for the time being, bitcoin is in many ways the best and cleanest payments mechanism the world has ever seen. So if we’re ever going to create something better, we’re going to have to learn from what bitcoin does right – as well as what it does wrong.

The source code for bitcoin is free and public, which means that just about every hacker and cryptographer in the world has had a crack at it. And they’ve all come to the same conclusion: it really works. There are question marks over just how anonymous it is and just how scalable it is, but when bitcoins first arrived in early 2009 – right at the height of a massive global crisis of capitalism – they had immediate and magnetic appeal to the anarcho-utopian crowd of techno-libertarians who drive an enormous amount of innovation online.

Salmon discusses at great length the difference between commodities and currencies.  He points out that the design of the bitcoin could effectively erase the distinction between a commodity and a currency.  But he says the usefulness of the bitcoin is limited by several factors:

  • Very poor liquidity - it isn't traded in any sort of market, there is no bank or trading house that offers a certain market for bitcoins.
  • Scarcity - trading volumes are typically about $20 million, only about 0.000000005% of the current foreign exchange market.
  • Hyperdeflation - if the bitcoin became the reserve currency the deflation preduced by the gold standard in the 1930s would be nothing by comparison.
  • Possible illegality -  the FBI is on the record as saying that “it is a violation of federal law for individuals… to create private coin or currency systems to compete with the official coinage and currency of the United States”.  NoteGEI News quoted a Treasury Department document that appeared to recognize the legitimacy of bitcoins.

But what Salmon says the value of the bitcoin experiment is that it is highlighting the need for a peer-to-peer frictionless universal payment system without any exchange costs/fees/commissions.  Of course there is a very large extractive financial system which doesn't see the world that way.


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