by Saumil Mathuria
What is Bitcoin?
Before getting into the intricacies of why there is a Bitcoin bubble, let us get a gist of what is Bitcoin. Bitcoin is the currency of the Internet: decentralized digital money, distributed worldwide. Unlike traditional currencies bitcoins are issued and managed without any central authority whatsoever: there is no government, company, or bank in charge of Bitcoin.
Is there a Bitcoin bubble?
A bubble is the state of an asset class whose price has deviated exponentially north of its intrinsic value because a significant number of its buyers are purchasing it not to actually use the thing, but simply because they expect its price to go even higher. Once this happens enough, the bubble “pops,” i.e. its price begins to plummet. Why? Because people begin to realize that the thing they were buying is not actually useful, or at least, not as useful as its price had been bid up to be.
Most people with things to sell don’t accept Bitcoin in exchange. So most choosing to hold Bitcoin do so knowing that they are holding something they will one day exchange for cash, before exchanging that cash for something they really want. In this sense, if Bitcoin is a bubble, it’s a bubble resting on another bubble. Cash is also worthless intrinsically, but it being backed by its country’s Central Bank makes it bankable.
Legal Tender Money:
You might often hear the argument that money is accepted because the law states that creditors must accept cash as final settlement [in this sense cash is ‘legal tender’]. But this has always struck me and no doubt others as superficial. Laws are costly to enforce. If conditions changed such that accepting cash was not wise, people would not accept it. So cash is a bubble, which might or might not burst under different pressures. And Bitcoin is a bubble blowing on a bubble, and holders are calculating that they might or might not be able to exchange for cash at some point, and might or might not (probably will) be able to exchange the cash they get for their Bitcoins for something they really want.
Bitcoin: Problem or Solution?
Bitcoin seems like a solution to a problem that doesn’t exist, or, if it does exist, is slowly being solved over time. One problem with currency is that it’s inconvenient to cart around. But electronic payments are slowly taking over, except for illegal goods. Another is that people can steal it from you. But Bitcoin also seems exposed to theft. Another is that it gets eroded by inflation. But societies around the world have slowly got on top of that problem too. Looking far out into the future, people speculate about a world in which we could engage in real-time wealth exchange. Perhaps swapping claims on indexed mutual funds.
Bitcoin may hold ‘long term promise’ and if people do switch to using it, then it will cause a problem for central banks, depriving it of a lever.
Those who think that using monetary policy for the purposes of trying to iron out booms and busts does more harm than good may think that losing this lever would be a good thing. Personally, I think it is worrisome.
Hedge against other monies?
Could Bitcoin be a kind of hedge against other monies? I doubt it. A world where all public monies are being debased feels more like a world that is facing catastrophe, and it doesn’t seem right to conjecture that virtual computer based monies would feel safe. If all the cash bubbles burst, surely the Bitcoin bubble would too. A world in which just one public money was being debased would be one in which investors could protect against by holding multiple currencies. So Bitcoin doesn’t seem to help here either.
Private monies like this may have a beneficial effect in creating a world where private monies would compete and discipline issuers not to debase their currency. Perhaps Bitcoin and other competitors that emerge might do the same. But then, as just mentioned above, this could have its downside if it forces central banks to generate inflation rates that are too low, or to avoid using monetary policy to stabilise booms and busts.
The Economist reported that the German Finance Ministry recognises Bitcoin as a ‘unit of account’. But that doesn’t amount to much. “I’m pleased to announce that anyone who wants to deal with me can count whatever they like in olives or marshmallows, provided they don’t expect me to take them as final settlement.”
Conclusion:
Finally to end the note, is BitCoin a bubble? Absolutely yes, Bitcoin is a bubble. All the signs are there including lots of people trying to convince themselves that it’s not a bubble. Bubbles are not necessarily a bad thing. Dot-com was a bubble. Microcomputers were a bubble, Biotech was a bubble, and railroads were a bubble. The Chinese economy is a bubble and has a boom and bust every three years. Bubbles are great things if it encourages people to get into something useful. There is not a single technological breakthrough in the last 100 years that has not caused a market bubble. So yes Bitcoin is a bubble. The bubble will pop. People will lose their money. But then the life will go on and Bitcoin will change the world.