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Matthew Cowie
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Financial Analyst for Mutual Fund Investor Guide; currently living in Beijing, China. Previously worked as a financial analyst for for Fidelity Independent Adviser Dion Money Management. Articles written have appeared on CNBC.com, Yahoo Finance, theStreet.com and Seeking Alpha.
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  • Some Thoughts On Bitcoin, And Why Bitcoin Is The Ultimate Bubble 2 comments
    Apr 7, 2013 12:19 PM

    Some thoughts on Bitcoins, some addressing criticisms, some not. Not an exhaustive list.

    First and foremost, Bitcoin is money if it is widely accepted as money (rising in value based on how wide the acceptance goes). If it is not money, then it is worth exactly zero.

    Every innovative technology has spawned a bubble. Bitcoins are something new and something old: private money that can only retain its value through supply management and reputation. The new aspect is decentralized open-source software.

    The world is experiencing great shifts in technology, economy and power. The information age, the reserve currency and the global superpower are all in question. Bitcoin can speak to all of these questions, which explains much of its attraction. Yet we can only predict the results, not know them. Bitcoin becomes a castle in the air,a vision of the future.

    Virtual currencies aren't new. Ledger book accounts were kept in Roman units of currency into the Middle Ages, yet few coins circulated. Depending on what measure of money supply you use, there may be as little as $1 cash USD for every $50 in money/credit.

    The Canadian Dollar/ U.S. Dollar exchange rate is roughly 1 to 1. The JPY/USD roughly 100 to 1. The Korean Won 1000 to 1. Fiat currencies have no inherent value, they are units of account. Bitcoin can be a functional currency for any range of non-zero values.

    Assuming Bitcoins survive as a currency, they could have a low value and high velocity or a high value and low velocity. Gold already serves as the high value low velocity money. Bitcoins (or something like them)could replace it in the digital realm, either as a currency for the digital economy or a truly global currency, serving as a long-term store of value. This is the bullish scenario for Bitcoin.

    For Bitcoin to maintain a high value it must be the thing itself being desired, not its transactional value. People need to want to hold it, to store purchasing power.

    Competing crypto-currencies increase the value of Bitcoin during the bubble phase. In the end, the market only needs on standard. Bitcoin currently as the inside track to being the standard.

    The idea of crypto-currencies aren't new. They have existed in science fiction for decades.

    There is a divide in society between people (generally skewing younger) who are familiar with open source software and distributed computing networks (every music and movie downloader is familiar). They trust the network, not the system. Older people trust institutions(and ultimately the men who run them). The people on each side look at the other as crazy: one side trusts its money to a distributed computing network at risk of hacking (estimates run as high at 10% of Bitcoins being stolen), while the other trusts in a handful of men that promise to steal you money via inflation (and issuing it to "themselves",their member banks, first).

    While Bitcoins are used for illicit activities, both VCRs and the Internet were spurred along by pornography, the Internet also by gambling and illegal music and movie downloads. Bitcoin will not prove to be much more of a haven for criminals than cash. The advantage of Bitcoin is the anonymity, if you can keep it. Most people will eventually want to exchange into cash, thus will voluntarily enter the banking system at some point.

    If you transact solely in Bitcoins, you could probably stay off the government's radar. However, if you are suspected of a crime and the government gets a warrant and can obtain your Bitcoin account numbers, they can trace all your transactions.

    The most interesting use for Bitcoins today is for international money transfers. Bitcoins can avoid capital controls. If Cyprus is repeated elsewhere and Bitcoins "gain currency," the price could double several times over.

    Bitcoin is still a limited bubble. There has been no widespread adoption. If Bitcoin becomes a true social bubble, like Tulip Bulbs, South Sea,Railroad Stocks, 1929 stock market, etc., then the Bitcoin bubble has not even begun to inflate. And yet as it stands today, I would not recommend investing in it because it is already a bubble.

    If Bitcoin goes wild, one day the stock of Bank of America or Amazon will jump 10% when they announce they are accepting Bitcoins. Then you will be able to compare the Bitcoin bubble to the tech bubble as a social phenomena.

    Why Bitcoin is the ultimate bubble: Bitcoin cannot become money except through a bubble phase. If Bitcoin cannot become a bubble,then Bitcoin will not be money and it will go back to a very low price. The bigger the Bitcoin bubble blows, the higher the final value of Bitcoin and the more legitimate the currency becomes. The higher the value, the higher the purchasing power, and the more businesses will accept them. Bitcoin needs to keep blowing the bubble to bring in more people and businesses to accept it.

    Bitcoin's transition to money can build slowly over time, but the whole time it happens slowly, many people will think Bitcoin is not money. When people decide Bitcoin is money, it will explode in price because it is then on par with francs, yen, yuan and dollars. Then it's limited supply will give it an inherent advantage as the fiat currency used for storing value.

    Today the big question is whether Bitcoins are simply a bubble headed for a burst, or actually entering a transition into being real money. Either way, it is the ultimate bubble. Nothing stands behind it, there is no Ponzi lie of guaranteed returns, no business, no tulips, nothing of any value to speak of except the possibility of owning a future currency. Yet unlike all those other bubbles, Bitcoin stands the greatest chance of going up and staying there, for the very same reason. It is the boldest financial gambit ever imagined, one that relies on its democratic appeal for its very success.

    Themes: Bitcoin, gold
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  • RHD
    , contributor
    Comments (447) | Send Message
     
    Interesting article; thank you. You have not, however, defined "bubble" adequately in this specific context; the "housing bubble" or the "Internet bubble" demonstrated quite different characteristics than the potential "bitcoin bubble" attemptedly articulated above. Please expand on the micro- and macro-economic "bubble" effects as differentiated from the USD or any other fiat currency.

     

    "Why Bitcoin is the ultimate bubble: Bitcoin cannot become money except through a bubble phase. If Bitcoin cannot become a bubble,then Bitcoin will not be money and it will go back to a very low price. The bigger the Bitcoin bubble blows, the higher the final value of Bitcoin and the more legitimate the currency becomes. The higher the value, the higher the purchasing power, and the more businesses will accept them. Bitcoin needs to keep blowing the bubble to bring in more people and businesses to accept it."

     

    I believe you have just described all fiat currencies.
    11 Apr 2013, 05:48 AM Reply Like
  • Matthew Cowie
    , contributor
    Comments (512) | Send Message
     
    Author’s reply » All fiat currencies are a bubble, yes. If at anytime they lose acceptance they go to zero.

     

    I think the only relevant model is political, such as Iraqi dinars in 2003. Do you buy the currency? Or do you think the government will collapse? U.S. Continentals and Confederate dollars hyperinflated during the wars because no one knew if the government would survive. In this case, it is money without a government.

     

    From FOA, talking about gold:
    ......
    Dollars bidding on MSFT stock set the value of that stock. If dollars are frantically bidding on MSFT (high velocity), the stock skyrockets. If dollars stop bidding for MSFT all at once (low velocity), the price falls to zero. This is true for everything in the world **except gold**.

     

    Gold bids for dollars. If gold stops bidding for dollars (low gold velocity), the price (in gold) of a dollar falls to zero.
    ......

     

    All of the investment bubbles are bidding for the object. Microsoft stock, Beanie Babies and tulip bulbs don't bid for dollars. Today, bitcoins are an object, they are not money, because dollars are bidding for bitcoins. If people stop buying them, the price will fall.

     

    At some point, people may begin mostly using bitcoins to demand goods and services (or dollars). At that point, it is money.

     

    The main difference with USD or other currencies is that there is no central bank, no legal force behind bitcoins, and people can buy into the system. This ability to buy into the system is what makes it competitive, because if a company tried this, everyone would refuse to buy, since the creator of the money stands to earn huge seigniorage profits. Since the creator of the money is anyone running the software, the seigniorage is distributed. Also, since there's no inflation beyond the 21 million units, there's no threat of the central authority stealing money through inflation.

     

    The speculative bubble exists as long as people are unsure if it is money or not. When it becomes money, it is just like any other fiat currency, but without central backing it will need to fend off competitors through superior value. One major portion of that value will be the wide acceptance, which means there's a huge advantage to being the first mover. If Bitcoin can become money, it will likely stay that way and defeat all competitors. If not, it is worth zero and something else will try for it.
    11 Apr 2013, 08:59 AM Reply Like
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