(Readers are urged to read the post on Bitcoins preceding this one, which you can reach using the link below)
As I predicted in a post around a week ago, the Bitcoin bubble finally popped. Though it took slightly longer than I anticipating, reaching an unheard high of $256 a coin before collapsing. The greatest indicator of the inevitable doom, I would say, was the endless media attention. Once something enters the news cycle, then the countdown clock goes into overdrive.
In my previous post, I explained Bitcoin’s nature and numerous weaknesses, including:
- No controlling authority.
- Not tied to any physical asset
- Price is driven entirely by user speculation.
- Open to wide-scale manipulation.
- It’s hackable, as are all things on the Internet.
- Governments will eventually get involved one way or another and attempt to regulate or control the currency.
Obviously, this isn’t good. If the purpose of Bitcoin is to be a currency which people will use to buy and sell and sell goods, then that requires the currency to be relatively stable. If the price of Bitcoins relative to the dollar is extremely volatile (shooting up to over $200 and then crashing down is NOT an encouraging sign), then few people would use it. A natural consequence of it being untethered to any real asset. John Angel, a professor at Georgetown University, expressed his thoughts in an article on Ars Technia:
“Even if there is a speculative element [with traditional commodities], at the end of the day you expect the price to have a gravitational pull towards the true value.”
“We have models for valuing stocks and bonds, so we can get a sense of what it’s worth. But I really have no way of figuring out what a Bitcoin is worth. Sure, I can go to exchanges and see what the current price is, but how do I know that that price tells me anything? If I look at the price of the euro, I know what I can buy with euros. I know how many euros it takes to get a Big Mac in Paris or a hotel room in Frankfurt. We have this idea called ‘purchasing power parity’ that says that sooner or later exchange rates should reflect prices across different exchanges. We don’t have that with Bitcoin.”
“Plus, traditional commodities like gold, oil, wheat, and others have practical value beyond their monetary value. Gold can be used as jewelry, or manipulated industrially to manufacture semiconductors. Oil can be used to power machinery or refined for gasoline. Bitcoins have zero inherent utility.”
The question of Bitcoin’s lack of intrinsic value is only the tip of the iceberg. After all, the United States dollar isn’t back on anything either. But as Ars Technica points out…
…it has a massive infrastructure designed to regulate and safeguard its function as a currency through institutions like the Federal Reserve, the Treasury Department, the Securities and Exchange Commission, the Commodity Futures Trading Commission and other entities.
Bitcoins does not have this sort of infrastructure. As Prof. Angel points out: “The bank that is storing my money is highly regulated by federal regulators and backed by a government with a huge army behind it.”
So Bitcoins, as a currency, has no intrinsic worth, has no worth based on solid trust, lacks regulation, can be manipulated, can be hacked, and so forth. You might as well be trading monopoly money for real money. And absent from the above list is something important I forgot to mention, which only adds to the number of issues that Bitcoin faces as a currency.
In my earlier post, I explained that you can buy Bitcoins on specialized online currency exchanges. The largest of these, Mt.Gox, handles 80% of all Bitcoin trades. So if the website were to go down, then the currency would quite literally be cut off.
This is precisely what happened.
Yesterday, as the price of Bitcoins hit new highs, people started selling Bitcoins en masse in order to rake in their profits. Naturally, as the selling intensified, the price of the coins started dropping radically. The bubble had begun to pop. Mt.Gox, in an attempt to calm things down and let the market “cool down”, stopped all trading. The result was predictable: massive panic, with people selling on the other exchanges. A friend of mine gave me this image, which aptly describes the situation:
Since the crash meant that people were rapidly losing money, people immediately demanded (read: begged) that the market be controlled or shut down. Amazingly, this represents a critical betrayal of the very principles that Bitcoin is supposed to stand for: a completely free market, unregulated or uncontrolled by anyone. Now, these same users are lambasting that “people are manipulating the market” (which was obviously from the beginning to anyone who bothered researching the nature of Bitcoins) and that there should be tighter controls on the trading of Bitcoins.
As a friend of mine said “It’s like watching 2008 all over again except this time with more stupidity”. In a moment, principles and belief in a non-centralized, non-controlled currency have been thrown out the window. The majority of people, it would seem, value their own personal money above the sanctity and ideology of the system they praised. I am sure there is much introspection going on right now, as people realize that their own greed led to this incident (except, of course, for those who insist this entire crash was an elaborate conspiracy).
But is Bitcoin dead? To put it simply: No. In fact, this is just the beginning. As The Economist argues, we are witnessing the emergence of something new here: math-based currency.
Bitcoin isn’t the only virtual cryptocurrency in town. There already exits a knockoff, Litecoin, which is in development. Of greater interest is Ripple, another tech-currency startup which will officially begin in May. If it is successful enough, argues The Economist:
If Ripple gains traction, even bigger financial players may enter the fray. A firm such as Visa could create its own cheap instant international-payments system, notes BitPay’s Mr Gallippi. And what if a country were to issue algorithmic money?
At that point, we would begin the transition from fiat currency to math-based currency. Something quite spectacular to look forward to.
Can we make money from this?
Well absolutely! In my previous post, I did leave a link indicating that Bitcoins could be shorted.
Currently, Bitcoins are floating around the mid-70s (USD) per Bitcoin. There seems to a resistance at $69 a coin, but it is yet to be determined if this is rock-bottom price. Regardless, now that the bubble has popped, wise and big investors should be considering whether or not to invest into Bitcoins at a relatively low price. The same applies for Litecoins, once the price stabilizes.
As for Ripple, The Economist makes an important point (emphasis is me):
OpenCoin is expected to start handing out Ripples to the public in May. It has created 100 billion, a number it promises never to increase. To give the new currency momentum, OpenCoin plans eventually to give away 75% of the supply. Existing Bitcoin users can already claim free Ripples and eventually anyone opening an OpenCoin account will also receive some.
The 25% retained by OpenCoin will give it a huge incentive to make sure that the Ripple is strong: the higher its value, the bigger the reward for OpenCoin’s investors when the firm cashes out. On April 10th several blue-chip venture-capital firms, including the ultra-hip Andreessen Horowitz, announced that they had invested in OpenCoin.
In short: plenty of opportunity exists, even though Bitcoin has just crashed. In the words of legendary investor Warren Buffett:
Be earful when others are greedy, and be greedy when others are fearful.