For us internet citizens, the story of the past couple weeks is bitcoin. It’s a virtual currency originally targeted towards anti-establishment libertarians and people looking to pay for things online that Visa and Mastercard won’t allow (read: illegal things). Ron Paul supporters who hate central banking, Wikileaks supporters trying to donate when major banks and credit card companies embargoed the site, and millennial hackers all got on board and kept the idea alive.
It’s now gone mainstream, as the first trimester of 2013 has seen an epic rise in what people will pay for a bitcoin. Observe:
Part of this is that bitcoin is a very slow-growing currency pool. Bitcoins are created though users processing transactions of the currency, in a process called ‘farming’. This creation has slowed over time- there is a cap on how many bitcoins will eventually exist (21 million) within the code of the currency.
Interest from influential people, and the continuing crisis in the Eurozone have led to bitcoins gaining value against most currencies, and a recent shot into the stratosphere. The problem is, bitcoin is a classic speculation bubble, and people thinking they’re going to get rich quick are likely to be disappointed.
This deflationary spiral- when the money supply is far too contained to deal with overall demand- doesn’t last forever. It depends on demand, but bitcoin has limited value beyond being currently valuable- many people who are buying now are not going to use it to buy goods and services. They’re looking to ride the surge and cash out. What we know from bitcoin being an open currency is that huge amounts of the currency are hoarded by a few people and cartels. They will eventually start dumping bitcoins back into the market. The people who buy it at $200 will need to see a large rise to make their investment worth it. Much like Amway or another pyramid scheme, first and second-generation investors have a vested interest in recruiting more people and hyping it up in the media.
I’ll do a little prediction as to how this will come crashing down. Bitcoin was created and promoted by anti-regulation, anti-government elements from all over the political spectrum. What this means is unlike your savings account at the bank (which is insured by the FDIC), bitcoin purchases are not- and thus they can be easily stolen or lost. People have lost thousands of dollars in a hard drive crash, because the bitcoins are specific pieces of data valuable to whomever holds them. This also means old fashioned bank robberies can and do happen- bitcoin banks, mutual funds, and exchanges are routinely hacked.
So, we have a new group of non-techie investors, a shockingly valuable currency that’s easy to steal, and institutions that routinely get hacked and are responsible to nobody.
What could possibly go wrong?