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The real cause of the Bitcoin bubble and burst

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MTGox

All the media has finally woken up to the Bitcoin phenomena when the value of Bitcoins rose from a steady $20 per coin to $266 last week … only to crash to $100 by the end of the week.

MTGox

What caused this?

The general consensus is that the financial crisis in Cyprus, which led to proposals to raid domestic bank accounts, set off a panic among Spaniards, who feared that the tumult would cross the Mediterranean and put their savings at risk. So large numbers of them converted their euros into digital Bitcoins.

If you’re not aware of this, they even wrote a song about it:

Just when the Cypriots were losing faith
That’s when I learned about the block chain
I still remember how it all changed
Satoshi said,
Don’t you worry, don’t you worry, child
Bitcoin has got a plan for you
Don’t you worry, don’t you worry now

Thanks to Zachary Seward, March 29th 2013

An alternative view is mine, which is that I presented to a conference in the Middle East in mid-February and at the end, a gentleman from Iran was asking me lots of questions about Bitcoin.  As Iran is off the financial system – the Iranian banks were ejected by SWIFT – putting all of their dollars (yep, that’s what everyone uses!) into Bitcoins would make perfect sense.

Whoever is doing what, the Bitcoin concept is now firmly known by one and all.  It does not mean it is used by one and all – Bitcoins are still pretty hard to use for general purchases and sales – and it does not mean that it is a mainstream economy – Bitcoins total market capitalisation is still only around $2 billion – but it does mean that Bitcoin is now firmly known.

So, in the interests of providing a little insight into what’s been going on, here’s a quick lowdown on Bitcoin.

First, if you want to know what Bitcoin is all about, read my earlier blog entries:

…. and / or watch this short video (it's a useful intro):

So the bubble began in March with a massive rise in value from the stable $20 per coin mark in January to almost $100 per coin by the end of March.

I was alerted to this personally when I read that man was selling his house for Bitcoins … when your house is worth less than a Bitcoin, something’s happening.

Then the Bitcoin bubble peaked at $266 per coin on Wednesday, 10th April, followed by a massive drop to just $55 in a few hours.

Bitcoin crash

It stabilised back at $100 later, but why the massive drop?

No-one seems to have a clear answer.  Some say it was a hack attack, others say it was people selling off and reaping profits, others call it a classic bubble burst.

I probably go with the explanation provided by the main Bitcoin trading exchange, Mt.Gox.

Writing on their Facebook Page Mt.Gox explain that they have been the target of DDoS  Distributed Denial of Service) attack:

As expected in such situations people started to panic, started to sell Bitcoins in mass, resulting in an increase of trade that ultimately froze the trade engine.

In other words, people lost their bottle, as is usual in a gold rush.

Regardless of the cause many of the media have used the bubble burst to write-off Bitcoin once again when, in fact, it has actually achieved the opposite.

The media hysteria of the past week or so has said everything from the vulnerabilities of the Bitcoin system, the fragility of its system, the ease of hacking the system, its usage for many dodgy purchases from drugs to weapons of personal destruction, and more.

These are all accusations that are thrown at Bitcoin on regular occasion since its start, and it has survived all of these challenges.

For example, Bitcoin has already had one bubble burst back in 2011.  Back then, the coin’s value rose from $2 to $30 and back again.

This is just symptomatic of a fledgling system and an economy that lacks liquidity mass.

This is why Bitcoin is not robust today – the system has not got enough liquidity – but the fact that Spanish savers, Iranian businesses and mainstream media are all now on the case of Bitcoin indicates that it will gain critical mass and, over time, mainstream acceptance.

After all, many of the Bitcoin community are aware that it is evolving fast.  It started as a form of net commerce that was as easy to use at TCP/IP – you had to program it.

Then it moved to HTML, and got easier.

Soon, it will be plug and playable into any form of transaction.

Then it will be a serious contender to challenge traditional money.

As the CEO of Bitpay, Anthony Gallippi, said at a recent payments conference: “Bitcoin is a new asset class where money can be stored in the cloud and accessed anywhere with any device for free”.

Now I like that. 

That describes it succinctly and perfectly as any money I can store for free in the cloud, use with any device and transact easily at low or zero cost makes sense to me.

Anyways, here’s the best of the coverage of the past week or so, if you want to know more about what’s been happening with Bitcoin.

Felix Salmon’s blog about it caught most people’s attention at the start of the bubble burst week.

The Bitcoin Bubble and the Future of Currency, April 3rd 2013

A few days ago, the value of all the Bitcoins in the world blew past $1 billion for the first time ever. That’s an impressive achievement, for a purely virtual currency backed by no central bank or other authority. It’s also temporary: we’re in the middle of a Bitcoin bubble right now, and it’s only a matter of time before the bubble bursts.

As he points out, reinforcing my point above: “A peer-to-peer payments system, allowing anybody on the internet to pay anybody else on the internet without having to sign up with some financial-services behemoth first, could revolutionize global commerce. “

The thing is that Felix obviously does not believe in Bitcoin or its economic usage and value.  Not only does he do a good job of critiquing its lack of critical mass in the first article, but follows it up in  his most recent blog effort:

Bitcoin is clearly not an effective store of wealth — just look at how quickly that wealth can be evaporated. Neither is it a useful payments mechanism, given how fast its value can fluctuate.

I personally do not understand that criticism as any new economic ecosystem will suffer during its formation from a lack of liquidity.  That automatically creates volatility as the system can be bucked until too many billions are in the system.

So Felix, I’m not sure where you’re coming from.

Anyways, as mentioned earlier in this piece, Zachary Seward on Quartz is another reliable Bitcoin media watcher.  He posted an early piece on April 8th  about the Bitcoin bubble:

The total value of outstanding Bitcoins surpassed $2 billion today, another milestone for the experiment in decentralized currency that was worth $1 billion just 11 days ago. It’s up about 1,300% since the beginning of the year.

Various media sites gave more coverage until the Wednesday drop, when Bitcoin news appeared everywhere!

One of the better articles about the boom bust comes from Time Magazine:

The volatile rise and fall of Bitcoins has prompted lots of stories explaining why the online virtual currency is a classic bubble. Many compare it with Tulipmania in 17th Century Holland, where the prices of rare tulip bulbs soared to absurd heights and then crashed, ruining the speculative investors who had bought them. But the Bitcoin phenomenon is more than a bubble. It says something important about the current and future state of the global economy …

The economic debacle in Cyprus keeps getting worse, after all; in fact, the losses there figure to be far greater than any that have occurred in the Bitcoin universe. In addition, the Federal Reserve, the European Central Bank, and the Bank of Japan are pumping out money like French assignats.

Of course, real countries do have massive wealth backing their currencies and their bonds, as well as the police power to arrest counterfeiters. And the U.S. dollar appears to be in better shape for the near term than most other major currencies. But the Bitcoin is doubtless only the first well-designed online virtual currency – and is sure to be followed by Bitcoin 2.0 and other even more sophisticated successors.

Could these online currencies ever reach a level at which they altered or obstructed government policy? President Clinton’s adviser James Carville famously joked that if he were reincarnated, he would want to come back as the bond market because “you can intimidate everyone.” Just as the so-called bond vigilantes acted as a brake on Washington’s fiscal policy in the 1990s, one day “currency vigilantes” could act as a similar brake on monetary policy.

The Internet will almost certainly offer access to a growing number of currencies in one form or another that are beyond national control. If a future Fed Chairman tries to repeat Ben Bernanke’s policy of Quantitative Easing (effectively printing money), worried investors could start pulling their savings out of the dollar and send it streaming into the Cloud so fast that the Fed would be forced to change course.

Governments will fight back, no doubt. But virtual currencies will be no easier to control than Facebook. Stopping the movement of capital will be possible only if countries are willing to impose harsh taxes and capital controls. Once alternative currencies are frictionlessly available on the Internet, every laptop will become its own Cayman Island. However the current boom-and-bust plays out, Bitcoin is the beginning of something, not the end.

I’ll leave the final quote to Gavin Andresen, a lead developer on the Bitcoin project:

Bitcoin is an experiment. Treat it like you would a promising Internet start-up company: Maybe it will change the world, but recognize that investing your money or time in new ideas is always risky.

Bitcion

 

Chris Skinner Author Avatar

Chris M Skinner

Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...

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