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February 2014
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February 3, 2014

Bitcoin - Is A Hard Crash Inevitable?

Category: Internet Marketing — Answers 2000 @ 4:51 pm

There is a lot of media hype about Bitcoin, a type of peer-to-peer virtual currency at the moment.

Most of this hype has been driven by the fact that the market price for Bitcoins has risen from about $10 to about $1,000 in about the last year (or is it the hype which has caused the price rise?). Some people have made a lot of money during this price rise, and although there have been a few serious hiccups during the price rise - some people think there is potential from making more money by speculating Bitcoin will rise further still.

I don’t think that I have nearly enough information to give an opinion about whether Bitcoin’s price will rise further, but I am going to make a prediction about Bitcoin’s future - one that Bitcoin fans aren’t going to like - I believe that a hard-crash is pretty much inevitable. In the past, during its rise in price, Bitcoin’s had some incredible price crashes - down by 30% or 50% in a day - but I’m talking about a price crash back down to virtually zero per coin.

First off though, I can clearly see that there is a significant innovation in the design of Bitcoin - one that many of Bitcoin’s critics fail to recognize. Bitcoin is the first peer-to-peer system for managing relationships of trust between multiple parties - this is the part of Bitcoin’s design that acts as a distributed ledger keeping track of everybody’s Bitcoins, and not allowing any party to cheat. (Previously attempts at digital currencies required one trusted party to act as a banker).

Peer-to-peer systems for managing a relationships of trust could well be economically important - and I think they almost certainly will be economically important to some extent (although I don’t know whether they will be a small niche or a huge) - but that actually has virtually nothing to do with with whether the “coins” used in Bitcoin’s network have any real value.

The fact is Bitcoin has no exclusive ownership of the peer-to-peer network of trust idea, and anybody can use the same idea to setup their own similar network for any purpose - whether it it be a digital currency (known as a “crypto-currency”) or anything else they might want. In fact, dozens, if not hundreds, of other groups already have already set up their own rival crypto currencies based on this same idea - and of course each of these other groups, have their own types of digital coins.

In summary, digital coins aren’t valuable, because there is no real barrier to entry to creating or “finding” as many as you want.

To give an analogy, if somebody in the 70s had said “this silicon chip thing looks like a valuable innovation”, then of course they would have been right. But if they had then gone out and bought as much silicon as they can, expecting it to appreciate in long-term value - they would have fundamentally missed the point. Sand (silicon oxide) didn’t become more valuable as a result of the rise of the computer industry - because we could easily dig more sand up from the ground whenever needed.

Likewise crypto-coins aren’t in my opinion going to get more valuable even if the peer-to-peer networks of trust become a really important industry. The fact is that we can always create more crypto-coins whenever needed (yes the other coins won’t be Bitcoins, but I doubt that matters in the long run, as they are perfectly good substitutes - being able to perform the same function but more cheaply).

Bitcoin’s price rise reminds me of beanie babies. Back then there were people saying “but they are only going to make 10,000 purple pandas*“, just like there are people today saying “they are only going to make 21 million Bitcoins”. The purple pandas went down in value, because everybody apart from beanie baby speculators realised that other brands of cuddly toy were perfectly good and much cheaper substitutes for purple panda beanie babies - and they had a very strong economic incentive to look for substitutes once speculators had driven the beanie baby price up to stupid levels.

Likewise, people who really want to use crypto-currencies (rather than speculate on them), have a strong economic incentive to find a substitute to Bitcoins, now that the price has been driven so high by speculation. And so I predict like beanie babies, and other markets before them, Bitcoin speculators will find out that the prices driven high by pure speculation, can crash to virtually zero at any time.

Of course, none of the above is meant to imply that some people won’t make a lot of money speculating on Bitcoins - I’m sure many will, by entering and leaving the market at the right time….

…This article is just my personal opinion, not intended as investment advice of any form - but if you disagree (or agree and have something interesting to say), please post a comment!

* Sorry if my knowledge of the precise description and numbers of varieties beanie babies is less than encyclopedic, or not even entirely correct, but you get the point.


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