My opinion hasn’t changed much in the month since I wrote my first post on how I think BitCoin is a pyramid scheme, ultimately destined to unravel unceremoniously when all the speculative investors decide to pull the plug and cash out of the BitCoin market. Still the discussion that that post spawned was quite enlightening, forcing me to clarify many points both in my own head and here on my blog. Since then there’s been a deluge of other blogs and press chiming in with similar opinions about BitCoin and how its intended purpose is far from its reality. There’s been enough noise about BitCoin’s issues that last week saw the first major dip in the exchange rate, and it hasn’t been smooth sailing since.
The image above is the historic trading price for BitCoins to USD on the biggest BitCoin exchange Mt.Gox. The BitCoin “Black Friday” can be seen as the first dip following the massive peak at around $30. Since that day BitCoin has been shedding value constantly with the latest bid offers hovering around the $18 mark. This is not the kind of volatility you see in something you’d class as a currency where single percentage changes are cause for concern and usually government intervention. In the space of a week BitCoin has shed almost half of its peak value which in any sane market would have seen suspension of trade to prevent a fire sale of the asset. The market isn’t showing any signs of recovering either as the market depth report from Mt.Gox shows:
There’s a very large discrepancy between the majority of seller’s idea of how much BitCoin is worth and what the market is willing to pay for it. The vast majority of sellers are looking to cash out at the mid-twenties range when the highest buy offer doesn’t even break the $20 mark. Any rational actor in this sort of market would be looking to get out before the market wipes out all of their value completely and for what its worth I believe the main speculators have probably already withdrawn from the market which is what triggered the initial dip in price. Liquidity in the BitCoin market is fast drying up and that will only serve to drive the price back to (or even below) its initial stable equilibrium.
On the surface this would appear to be the beginning of the end for BitCoin since confidence in the currency is rapidly disappearing with all the accumulated wealth that’s being lost to the diving market. However whilst many who were hoping to make their riches with a nascent currency might be finding themselves short changed the diving price of BitCoins means that those who were working against the currencies intentions, I.E. those who were using it as a speculative investment vehicle, are more likely to leave the market alone now that it’s been pumped and dumped. Once the price retreats back to more stable levels BitCoin could then start functioning as it is supposed to, as a vehicle for wealth that has no central authority regulating it.
It’s not going to be an easy road for BitCoin and its adopters though as confidence in the currency has been dashed with even some of its earliest supporters withdrawing from it. Mining will then no longer be a profit driven enterprise, instead run by those who support the idea and large companies like Mt.Gox who run exchanges. Once the idea that BitCoin’s value would ever be increasing has dissipated we may finally see a point where BitCoins are primarily used as a vehicle for value transfer and not speculative investment. It will probably be another month or two before we reach a new stable equilibrium in the BitCoin market but after that I might finally stop harping on about it being an elaborate (though probably unintentional) scheme.
This still doesn’t detract from the concentration of wealth for early adopters in the BitCoin ecosystem but once their incentive to hoard currency has vanished then the impact of their vast BitCoin stashes means a whole lot less than it did during the speculative price explosion. This will encourage them to put those BitCoins into circulation adding much needed liquidity to the market and hopefully restoring some more faith in the system. Time will tell if this works out however as with market volumes so low on the BitCoin exchanges price manipulation is bound to happen from time to time and realistically can only be solved by having wider adoption. I’m still not convinced that BitCoin is a safe place for any of my wealth currently but once its recovered from this rapidly bursting bubble I may revisit it, should the want arise.
I’ve been on these Internets long enough to have seen my share of pyramid schemes masquerading themselves as something “revolutionary”. Back in the early 2000’s I can remember getting swept up in all sorts of “make money online” things that promised to pay you big bucks if you did surveys, clicked on links and some for just simply browsing the web. I also had a hand in bringing a few of these down, like many users of it did, when the system only did minimal checks on new users making it quite easy to make 1 person look like 200. I still keep a couple trophies of that time (a couple CDs I bought with Beenz) mostly for the sick pleasure I get in knowing that those companies were doomed from the start.
Over the years many other forms of alternate currencies came and went as did the venture capital dollars that had been invested in them. I think the last one I ever tried was EmailCash which has managed to survive by not trying to become an alternative currency, preferring to stay in the lucrative world of rewards programs. After I realised the effort I was putting into the schemes was netting me a return of much less than $1/hour I gave up on them completely and spent more time at my real job.
The idea of a inventing a currency is a tantalizing one though and the most recent addition to the long list of alternative currencies is becoming a hot topic amongst the tech community. I am of course referring to the BitCoin sensation, a decentralized peer to peer currency that allows users to “mine” BitCoins by acting as part of the payment network. It’s a very interesting idea especially when it adopts many characteristics of the platform its built on, allowing for truly anonymous transactions and a currency that can’t be controlled by any government. However, whilst I love the core idea behind BitCoin, I can’t help but feel this is an extremely elaborate pyramid scheme, and I’ll explain why.
Take a look for instance at this graph detailing the predicted number of BitCoins over the coming years:
BitCoins have an upper limit on how many can be produced, approximately 21 million if we take the creator’s word for it. BitCoins are almost infinitely divisible however so they can still be used quite extensively once the upper limit on the number has been reached. However the complexity in mining a BitCoin increases considerably over time as they start to become mined out and is accelerated by the number of people participating in the network. Thus the true benefactors of the BitCoin system are those who were in it from the beginning as back then it was relatively easy to generate BitCoins and thus they could amass quite a large amount of wealth in a short amount of time.
Like any alternative currency however BitCoins are completely useless if you can’t exchange them with other people for goods and services. It is then in the best interests of the early adopters to get other people to accept them as a legitimate form of currency. This means getting more people on the BitCoin network which, strictly speaking, doesn’t have a traditional referral system in place so it usually passes the pyramid scheme sniff test of most people. Still every additional member that joins and participates in the network is generating value for all of those that came before them, thus it is better for someone to “get in now” before the gold rush hits and the potential wealth disappears.
Also BitCoin, whilst being quite resilient to most exploitations, is still a computer system that can be manipulated. Most recently it came to light that one of the pools, DeepBit, managed to reach the critical 50% threshold of computing power that would make exploitation possible. Whilst it quickly sank back down in order to avoid such a scenario such a situation and no exploits were detected such a situation had only been “theoretically” possible until it actually happened. If BitCoin garners mass adoption you can bet there will be bot herds targeting the network in an attempt to exploit it. Whether they will be successful or not remains to be seen.
Given the rather checkered history that alternative currencies have I’ve been casting a sceptical eye over anyone who thinks that they’ve got this problem space solved, and BitCoin is no exception. Sure I was little excited about being able to generate some cash with spare CPU cycles but that feeling that this whole thing is just an elaborate pyramid scheme was too hard to shake and I’ve left it by the wayside. As a payment system it might not be a bad idea but the whole idea behind mining coins just means you’re paying to make the early adopters rich and that’s the main reason I take issue with the BitCoin system. It’s really hard to trust something when its structure too closely follows that of the ye olde pyramid scheme.