News Column

Bitcoin Digital Boom and Bust

May 17 2013 1:28AM

Alex Hern

Bitcoin wallet. (Image: electrum, Creative Commons)

Bitcoin is an anonymous, peer-to-peer, digital currency, which uses ingenious cryptographic technology to solve the problems of trust that have blighted attempts to create non -centralised forms of money for centuries. But that's not why Bitcoin is in the news. It's because you could buy one Bitcoin for $14 in January this year - and if you had, you could have sold it for $140 at the beginning of April. By the time you read this, it could be $1,400 -or $1.40.

Everyone has a theory about where the boom has come from. The currency has a core of diehard fans, drawn from communities focused around cryptography, libertarianism and the presidential campaigns of the American former congressman Ron Paul. They cite the absence of any centralised authority as a big selling point. In that narrative, the lack of trust in central banks not to inflate their way out of economic crisis is pushing people towards a currency with algorithmically determined hard money. (The Bitcoin rate of inflation is fixed and declining; the last coin will be "created" in 2140.)

There's anecdotal evidence to back that up. A recent report in Wired suggested that, following the Cypriot deposit tax, downloads of Bitcoin apps, required to spend the coins, surged in Spain. Were scared Europeans moving their money into a currency designed to be anonymous - and thus untaxable? But although the fans of Bitcoin have an enormous distrust of central banks and elected governments, that doesn't seem enough to explain the spike in the exchange rate.

For one thing, the boom started long before the Cypriot troubles, during a period in which Europe was comparatively stable. For another, the evidence in favour of a flight from euros to Bitcoin is sketchily inferred from poor data, and far outweighed by evidence of a real flight to US dollars and roubles.

To explain Bitcoin's parabolic rise, we should look not to technology, but to tulips. The currency is in a classic speculator's bubble. Once the rise became obvious, people rushed to buy coins, hoping to profit from its continuation; that pushed the price even higher, sending an even bigger signal to speculators; until you end up in a situation where it can jump by 10 per cent overnight, as it did on 3 April.

Eventually the bubble will pop. It is all too transparently driven by hype, and no one wants to be left holding assets after the peak - which has led to the sort of panicky behaviour that can cause a 9 per cent plummet in an hour with no event triggering it.

What will be left will be a slimmed-down idea, at a slimmed- down price. That version of Bitcoin - one of small-scale e-commerce, not hedge funds and house sales - could be a blessing to the internet, taking on titans such as PayPal by offering a new way to send money online. But to get there from here, a lot of people are going to lose a lot of money.


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