Anyone who keeps an eye on the papers will have noticed various news stories emerging recently of the enormous boom in the price of Bitcoins (USD/BTC). An asset that can easily double in value over the course of just a few days is clearly one to watch out for, and one where a lot of money can be made or lost very quickly. Right now we're hanging over a precipice though, with prices at all time highs and very little to support their position. There are a number of simple arguments surrounding the Bitcoin price boom that I want to touch upon, and consider whether they really hold true.
Bitcoins can be mined, but ultimately there is a finite number (around 22 million) that can be created, and after that point no-one can ever "print" more of the currency. This immediately has its draws, and is a great tag-line to sell to the would-be speculator. What is the real value of this though?
To take an analogy, there is a finite amount of material on the earth. When you break it up into elements you find that some are more common than others, and some are more useful than others. When you strike upon one that is both useful and rare you have an element of high value. At a simplistic level, this is what happens with GOLD. It is for this reason that people compare Bitcoin to gold, and many even suggest that it could replace gold as a store of value. Is Bitcoin really the same?
The answer, I think, is no. To start with, look at the number of alternatives on this website. All of them have the same finite number argument, but Bitcoin is actually very similar to most of them. In fact, there are almost infinitely many ways of developing a cyptocurrency similar to Bitcoin. In the same way are there are many elements of limited quantity on earth, there are many possible cryptocurrencies. Yes, Bitcoin is limited, but does it provide an exceptional use in a similar way to gold? Let's look at the major uses.
1. Transaction-fee free payments. This is one of the strongest arguments behind Bitcoin, but does it actually mean that Bitcoin needs a high value? Think about the process, if you actually wanted to use Bitcoin to transfer funds. You would first go on the internet and buy Bitcoins (using your normal currency), you would then send them to your friend/relative, who in turn would convert them back into their normal currency. Does it therefore matter what the value of the Bitcoin is? Unless you are ALSO deciding to speculate on the market (i.e. hold Bitcoins for a given period of time) then the value (provided it is non zero) is irrelevant. You simply buy the number of Bitcoins needed for your particular dollar (or other currency) value and transfer it, where it can be exchanged for the same value in whatever currency is needed.
2. To purchase legal goods and services on the internet. It is clear that its use for this is becoming more wide spread. More companies are accepting Bitcoin payments and it's gaining wider acceptance. The benefit over using a card is that it costs the business nothing to accept the payment, but will this really lead them to pass that cost advantage on to you? Do they really want to hold a volatile currency, instead of the stable dollar? The cost of that volatility is ultimately likely to cost them more than a marginal percentage charge on your card payment, so unless Bitcoin hits a very stable value I can't see this being of use.
3. Speculation. This is probably the main reason for the current rise in the price. Holding Bitcoin can double your money quickly, and so a lot of people head out to buy it. Who's to say whether this has been the only factor driving the current boom (I would argue that it is) but as soon as large amounts of speculation get involved you generate even greater volatility, and with that even greater crashes.
4. Purchase of illegal goods/services. There is a common myth that Bitcoin purchases are untraceable, and therefore perfect for illegal activity. Whilst this is true to an extent, every transaction ever made is recorded online for anyone to analyze at a later point. As algorithms used to detect fraud by governments get more advanced it's only a matter of time before this availability of data becomes massively negative to those wanting to act in the shadows. It's no substitute for cash, and never will be.
In only one of these does Bitcoin hold real value over other cryptocurrencies, and that is the use for purchasing legal goods and services on the internet (because use is ultimately defined by whether the company accepts it as a payment method). Not only do the others not hold as strong reasons for a price boom, they are also replaceable by any of the other cryptocurrencies available.
Ultimately, I think the current price is speculation driven and has no grounding for the two main reasons listed above. Firstly, Bitcoin is not unique. Other non-replicable cryptocurrencies can be created, and Bitcoin holds no special value over most of them (apart from early adoption). Secondly, the "use" argument falls through because of the irrelevance of the current price to users who are converting to Bitcoin just before payment/transfer. Of course this has supply/demand issues on the currency, and one can calculate a "utility value" of the currency based on this, but I can assure you that even a bold "utility value" estimate will not get you anywhere close to the current bubble price.
Sell Bitcoins now, and profit from the bubble.