From comments and articles I've been reading it seems like the same exact crowd active in the last bubble are back at it again. Those with libertarian ideologies have hopped off one bandwagon and seamlessly transitioned to a new one. While the iShares Silver Trust (SLV) and the SPDR Gold Trust (GLD) were the subject of their delight previously, the "cryptocurrency" bitcoin (BITCOIN) appears to be what is now in fashion. I find this transition particularly interesting since much of the hoopla surrounding the rise of precious metals was a lack of faith in fiat currencies according to them. When looking at bitcoin, it pretty much operates as the ultimate fiat currency.
Commodity-backed currencies are backed by the commodity and the United States dollar is backed by the power of the government. Bitcoins, well, they derive their value essentially from the greater fool theory. They do share something in common with the obsolete gold standard though. Bitcoin has its money supply fixed. So while the total amount of the currency has an ultimate limit, the dollar value of it floats freely.
And freely it has, as it has been behaving rather erratically to say the least. After being slightly over $10 at the start of the year, the currency rose to over $1,200 recently. However, in the last few days we've seen it fall around 50% and then bounce back to a little under $800 as I write this. Much of the drop had to do with China, the world's biggest bitcoin trader this year, effectively banning the currency from use by financial institutions.
So why is so much attention being given to this currency? Is it really because it could possibly "destroy the dollar" as former congressman and libertarian hero Ron Paul claimed? That's rather ridiculous and a pipe dream for fantasists. With the USD, you know to a very high degree of accuracy what $1 will be worth tomorrow, next week and next month. You can plan accordingly. Can you do that with bitcoin? Certainly not now. Will you ever be able to?
Presently there are approximately 12.1 billion bitcoins in circulation. The software for the currency has rules which govern the supply. The maximum which can be produced is 21 billion by 2140. As people inevitably lose their bitcoins through- forgetting a password, throwing away hard drives with bitcoins on them- the supply will inevitably be destined to fall.
Deflation is inherently built into the system. Indeed, what has happened recently has essentially been massive deflation. But that shouldn't imply rising prices are inevitable, still making this viable as an investment if nothing else. Demand for the currency will have to continue to grow and frankly, I just don't see it.
Bitcoins have novelty on their side, the appeal of operating outside the bounds of the coercive power of the government according to some. But sooner or later people will realize they aren't quite "sticking it to the man" as much as they are to themselves. China's actions are probably not the last. I anticipate the US government eventually taking similar actions, as there is already discussions taking place about which laws apply to it. With the regulation, out goes the appeal.
Just like the transition was made from precious metal mania to bitcoin mania, it will be placed elsewhere. While for long-term holders of the currency unrealized gains are attractive, the currency itself has been the antithesis of attractiveness as a currency. It hasn't behaved anything like what we seek in a currency. The main goal should be to smooth the way for transactions to take place. Bitcoin fails severely here, and that is why ultimately speculators will fail too if they look at this as anything other than involvement in something short-term and highly speculative in nature.
Because of the rise in price transactions in bitcoins were actually lower this fall than earlier in the year despite its surge in popularity. People are hoarding it instead of spending it, which they are incentivized to do thanks to deflation.
This is a very interesting article which touches on the very subject of hoarding bitcoins. The individuals in it are down on their luck and they sold their bitcoins for food. A decision they now lament because of how high the prices have gone. They literally wish they went hungry and hoarded the bitcoins instead! The economic ramifications of this depressed activity are pretty self-evident.
In short, bitcoin's failure is that it is a novelty which just isn't actually very useful. Save for anonymous purchases of illicit materials on the internet- which is where a lot of the transactions have been taking place- it just doesn't have much of role in facilitating transactions that isn't already better served by what we presently have. We have a tremendous amount of ways to make electronic transactions currently.
Hopefully in the end there is a lesson to take away from all this though. Recently there have been some egregious calls for a return to a gold standard, despite it being something tried throughout the world already and something which failed for a reason. Reasons we can see in the microcosm of the bitcoin universe and its fixed-money supply currency. That is, the depressive nature on the economy when deflationary forces lead to a hoarding of a currency, coupled with restraints on policy to satisfactorily do anything about it.