I had given up on writing on BitCoin because of the rather toxic community of people that seemed to appear whenever I wrote about it. They never left comments here, no instead they’d cherry pick my articles and then never attempt to read any of my further writings on the subject and then labelling me as a BitCoin cynic. It had gotten to the point where I simply couldn’t stomach most BitCoin articles because of the ensuing circlejerks that would follow afterwards where any valid criticism would be met with derision usually only found in Call of Duty matches. But the last couple months of stratospheric growth and volatility have had me pulling at my self impost reigns, just wanting to put these zealots in their place.
Since I can’t find anything better to post about it seems that today will be that day.
The last time I posted about BitCoins they were hovering around $25 (this was at the start of the year, mind you), a price that was not seen for a long time previously. It began a somewhat steady tend upwards after that however it then had another great jump into the $100~$200 range something I long expected to be completely unsustainable. It managed to keep around that area for a long time however but the end of October saw it begin an upward trend that didn’t show many signs of stopping until recently and the past couple weeks have been an insane roller coaster ride of fluctuating prices that no currency should ever undergo.
Much of the initial growth was attributed to the fact that China was now becoming interested in BitCoins and thus there was a whole new market of capital being injected into the economy. Whilst this might have fuelled the initial bump we saw back in the end of October the resulting stratospheric rise, where the price doubled in under a month, could simply not be the result of new investors buying into the market. The reasoning behind this is the fact that the transaction volumes did not escalate at a similar pace meaning those ridiculously unsustainable growth rates were driven by speculative investors looking to increase the value of their BitCoin portfolios, not a growing investor base.
The anointed champions of BitCoin won’t have a bar of that however, even when the vast majority of forums were flooded with people who were crying when they cashed out at $400, lamenting the fact they could have had 3 times more if they’d only waited another week. As I’ve said dozens of times in the past the fact that the primary use of BitCoin right now is speculative investment is antithetical to its aspirations to become a true currency. Indeed the fact that it’s deflationary means that it inherently encourages this kind of action rather than being a medium for the transfer of wealth between parties. Indeed the inflationary aspect of fiat currencies, which BitCoiners seem to hate for some reason, encourages people to spend it rather than simply hanging on to it.
The flow on effect of this rampant speculation is the wild fluctuations in value which make using it incredibly difficult for businesses. Indeed any business that was selling goods for BitCoin prior to the current crash has lost money on any goods they sold simply because of the fluctuations in price. Others would argue that typically the retailers are better off because the price of BitCoin trends upwards but history has shown that you simply can’t rely on that and it’s guaranteed that unless you exchange your BitCoins for hard currency immediately after purchases you’re likely to hit a period of instability where you’ll end up on the losing end of the equation.
Whilst I’m sure I’ve lost all the True BitCoin Believers at this point I feel I have to make the point that I think the idea of cryptocurrencies are great as they’d be a great alternate method for transferring wealth across the world. BitCoin has some fundamental issues, many of which can’t be solved by a simple work around here or there, and as such whilst I won’t advocate its wholesale abandonment I would encourage the development of alternatives to address these issues. Unfortunately none have been particularly forthcoming but as BitCoin continues to draw more attention to itself I can’t imagine they’re too far off and then hopefully we can have the decentralized method of transferring wealth all BitCoiners like to talk about.
BitCoins are a hybrid of two currency models, namely the current world standard of fiat currency (I.E. BitCoins only have value because other people will accept them in exchange for goods and services) and the traditional gold standard due to the availability being limited. Combined with the other properties such as transaction anonymity (within reason), no central system regulating transactions and worldwide reach BitCoins have all the features it needs to be a great vehicle for the transfer of wealth. Long time readers will know that there are some issues that plague the BitCoin ecosystem, mostly due to its relatively low transaction volume and misclassification as an investment vehicle by some, but these are things that can be solved with time and more investments.
One thing that always gets to me though is any time that BitCoins start to trend upward nearly every news outlet looking for a story will herald it as a second coming of BitCoin after the devastation wrought by the speculative bubble last year. I’ve made the case several times over that an increase in price is no indication of health within the BitCoin economy and in fact any sharp uptick in price is actually quite hurtful as it signals that BitCoins are better left unspent as it makes no sense to spend them when simply waiting will give you a discount. This hoarding mentality is what led to the speculative bubble last year as supply dried up and prices went through the roof. It didn’t last long however and the price came crashing back down to reality (and then some).
I don’t discount that all growth within the BitCoin economy is a bad thing however, just the volatility. Indeed there was a good period of 6 months this year when BitCoin’s price was relatively stable and that’s what it needs to be in order for commerce to take the currency seriously. Taking this idea further there has to be a price equilibrium where the exchange rate is truly representative of all the wealth contained with BitCoins and this is the point where the market should aim towards. Figuring out that particular price isn’t easy though and I can only really give a semi-education guess as an answer.
The longest time that BitCoin spent in relative stability was around the $5 mark from around May this year. Since then there have been another 1.2 million BitCoins added into circulation, an approximate 13% increase. In a completely stable exchange this would have put a downward pressure on the exchange rate which would have decreased the real value by a similar percentage. To keep the value “ideal” then, I.E. the real purchasing power the same, the exchange rate should go up by that rate instead giving us a new price of $5.65.
Of course this completely ignores the amount of potential wealth that could be contained within the BitCoin economy. A country’s currency is usually a reflection of the health of its underlying economy and BitCoin is no exception to this but we don’t have other metrics like GDP in which to get a good idea for how much wealth is backing it. Transactions volumes, exchange rates and total coins in circulation are only rough metrics and we’ve seen in the past how these things aren’t great indicators for the health of BitCoin.
Realistically the best exchange rate for BitCoins will be the one that it ultimately settles on once transaction volumes ramp up again and the investor market segment starts to become more and more irrelevant. Whether this is above or below the current rate is really anyone’s guess however we should still abstain from saying that the rising price of a BitCoin is a sign of market health as it’s simply not. Whilst the price rise is no where near as rapid as it was last year it’s still light years ahead of any other currency on the planet and as history has shown that kind of growth just isn’t sustainable. The next 6 months will be very telling for the BitCoin economy as we’ll see if this growth levels out into a new stable equilibrium or if it’s just the beginning of another speculative bubble.
It’s no secret that I’m somewhat bearish when it comes to BitCoins. Fundamentally I think the idea is sound as cryptocurrencies have the potential to revolutionize the currency and exchange industry in the same way the Internet did for the communications. The current implementation though is plagued with non-technical problems mostly due to how easy it is to influence the price with transaction volumes that aren’t particularly large. Transaction volume has been increasing however and when this is coupled with conversion stability we will have the potential for cryptocurrencies to move out of the tech niche they’re in and become a fully fledged means for transferring wealth around the world.
Getting BitCoin to work then relies on making it a desirable currency to use in place of more traditional means. For the most part people have focused on using it either as an add-on to their existing business (we now accept BitCoins!) or creating a new business from scratch based solely around the idea of using BitCoins. If I’m honest the latter feels like people seeing BitCoins as an opener to their 4 Hour Work Week style businesses which, especially if their only distinction from the competition is accepting BitCoins, don’t do too well in today’s aggressive market place.
Apart from these types of businesses and the ancillary ones that surround every currency (exchanges, banks, gambling sites, etc.) I hadn’t really seen much innovation in the BitCoin space right up until I read an article about CoinLab.
CoinLab is in essence a library for game developers that allows users to generate in game currency in exchange for using their idle compute power to mine BitCoins on the network. The idea is that oing this will net the companies much more dollars per user than advertising or micro-transaction due to the seamless nature of it and the tendency for people to do almost anything to get something for free. The idea isn’t particularly new, there have been many products that have paid users to use their extra computing power, but the integration with BitCoins certainly is. The question then becomes how sustainable such a business model is and going off the fact that CoinLab just netted $500,000 from investors to prove the idea would lead you believe that there’s some merit to this idea.
The last few months have been rather good for BitCoin with the price being stable at around $5. Additionally the transaction volume has remained relatively steady showing that there’s base level demand for the currency that can be depended on. This works in CoinLab’s favour as a business model that was viable during the speculative bubble last year would not be long for this work, but at a stable and predictable rate of conversion you’re far more likely to hit on a sustainable business rather than a flash in the pan. What’s working against them however is the increasing difficulty built into the system which will make generating new coins harder over time.
This is somewhat counteracted by increasing user numbers which gives you more compute power and thus more chance at getting coins, but it’s the difference between the two that will be the deciding factor in how far the business can scale. The end game for such a company would eventually be a transaction processing house using their legions of computers as a big exchange network and taking transaction fees instead of mining but whether that’s sustainable or not is a question I don’t yet have the answer to. It will be very interesting to see where CoinLab goes with this and I hope they’re as open with their figures as the rest of the BitCoin industry has been thus far.
BitCoins are definitely a catalyst for new kinds of innovation in an industry that’s typically been glacially slow to integrate with new technologies. Startups like CoinLab are doing the hard yards to make cryptocurrencies viable for everyone else by increasing the base transaction volume so the price isn’t as susceptible to wild manipulation like it was in the past. I may still be bearish on the BitCoin idea but many of my initial complaints are starting to be overcome through innovative uses that I hadn’t once thought of. I’ll be watching developments in this area keenly and who knows, I might even dive into it myself.