Is Bitcoin a bubble?

by on April 26, 2011 at 7:14 am in Economics, Uncategorized | Permalink

Last post on this topic!  Jerry Brito reports:

The arrow notes the date my column on the virtual currency was published in TIME.com. The day after that piece was published, the Bitcoin exchange rate reached an all time high at $1.19. Yesterday, just over a week later, it was pushing $2.

Via Chris F. Masse, Reuben Grinberg (in a useful paper) reports:

In late April, 2011, one bitcoin is approximately at parity with the US Dollar — a 2000% percent appreciation against the Dollar in less than a year.

Of course, that’s the appreciation you might expect from a highly successful private asset!  Or you can take that as a sign of the dependence of the Bitcoin upon expectations, and a sign of its bubbly nature.  Just think how hard it is for a major country to establish crediblity for its currency, and then ask how much of the Bitcoin value is expectations-dependent and multiple-equilibria dependent.  What will be the rate of Bitcoin appreciation five years from now?  I guess it will be falling.

If you are thinking about holding Bitcoin, here is a Fischer Black paper worth reading.

Zach April 26, 2011 at 8:23 am

According to http://bitcoinwatch.com/, the market capitalization of Bitcoin is currently about $9.3 million. That’s not very much money. Regardless of the long-term prospects for the currency as a store of value, it seems likely to me that given the recent publicity and how perfectly suited Bitcoin is to shady dealings, the total amount of money in the Bitcoin economy at any given time is bound to grow faster than the number of Bitcoins in circulation up to a point. If it does attain some kind of status as the underworld currency of choice, at least temporarily, I have a hard time seeing how it doesn’t appreciate in the short term. If an online gambling site adopts Bitcoin, it will explode overnight.

Long story short, I put $50 into Bitcoins. I don’t care if I lose that money, but the potential upside for an early-adopter strikes me as large.

JCL April 26, 2011 at 9:23 am

I’ll take $50 too if you want. See what I can do with it.

Rahul April 26, 2011 at 10:45 am

How are you going to liquidate those $50 eventually? The list of sites that accept bitcoins seems pretty crappy, at least for now.

Is there an option for a bitcoin–to-dollars conversion service offered by someone? What’s the commission.

Zach April 26, 2011 at 11:44 am

I bought my Bitcoins on an exchange called Mt. Gox. You put money into the exchange through wire transfers and all of the other ways to move money around on the internet that I’m sure poker players are very familiar with (I’m not a poker player, so this is all new to me). Once you have dollars in your account, you can trade for Bitcoins. it’s a pretty slick system, actually. You can sell off your Bitcoins (assuming there are buyers) whenever you want and withdraw the balance though Liberty Reserve.

Alternatively, you can trade with people directly for PayPal transfers, Amazon Payments, whatever. Rather than going through the hassle and risk of wiring such a small amount of money, I found someone in the #bitcoin-otc IRC channel that exists for direct trading who was willing to transfer me funds on the Mt. Gox exchange for an Amazon Payment + 7%. #bitcoin-otc has a pretty sophisticated authentication and rating service to track reputation, so I didn’t feel TOO in danger of being ripped off. There are various other conversion services. Coinpal sells Bitcoins through PayPal with a 7% fee. There is a need for a more streamlined conversion service – serious nerdery is required right now, but I feel as though my Bitcoins are fairly liquid right now. The risk is mostly tied up in the exchange rate volatility.

Anyway, it’s obviously not a serious investment vehicle and I’m in it to investigate/participate in the subculture because I think the technology is cool. That said, I do think the probability of significant appreciation in the short term is somewhat greater than zero.

Rahul April 26, 2011 at 12:34 pm

I’m convinced. Bitcoin gets $50 from me as well. A 2000% rise is always a head turner.

Dan Weber April 26, 2011 at 12:41 pm

Give me a time machine to a year ago and I would put thousands of dollars into Bitcoin.

Bitcoin has had a big run-up. So has gold. So had Qualcomm at the end of 1999. That was orthogonal to them being good investments.

In order to be useful as a trading currency, Bitcoins can’t fluctuate significantly in value over a week (the time it takes to ship something to someone). In order to be a store of value, Bitcoins can’t fluctuate significantly in value over a year.

Ringo April 26, 2011 at 11:17 am

“IF” a gambling site adopts Bitcoin? It has already happened. Check out btcsportsbet.com – global, anonymous, with fast, no fee deposits/withdrawals. No other bookmaker can compete with that. No other currency can provide that either.

mpkomara April 26, 2011 at 8:27 am

How many bitcoins will there be five years from now? about 14.75 million in April 2016
How many dollars will there be five years from now? depends
advantage: bitcoin

Explodicle April 26, 2011 at 9:01 am

That stabilizes supply but not demand.

Alex Godofsky April 26, 2011 at 10:21 am

It’s not like the Fed has been any good at stabilizing dollar demand recently either.

Dan Weber April 26, 2011 at 12:44 pm

I wish the dollar were more stable, but a USD is still vastly more stable than a BTC.

I want Bitcoin to succeed, but the path to success is not to ignore its problems.

M. Dutton April 26, 2011 at 7:06 pm

@ the end of 2009:
Bitcoins: ~1.3 million
US monetary base: ~2.0 trillion
Ratio: ~1.5 million to 1

Yes, the logic is perfect.

tom hynes April 26, 2011 at 9:55 am

Intrade should open a futures market in Bitcoin – say the conversion value 2 years from now.

Tyler and I will be on the short side.

koin April 26, 2011 at 10:24 am

you aren’t appreciating what really is going on here

bitcoin is becoming the common bond for those who feel they got stiffed. it is a way to stick it to the man. it is another form of going galt.

Chris April 26, 2011 at 10:31 am

I don’t think its a bubble. Current prices imply that the chances of it becoming a real currency are about 1/100 or so. I don’t think it’s unreasonable to think the odds are better than that.

Dan Weber April 26, 2011 at 12:45 pm

So a Bitcoin would be worth ~$100 if it’s a real currency? Where does that number come from?

Geoff April 26, 2011 at 1:57 pm

Presumably an estimated market cap of ~$1B upon wide adoption.

I would actually think it to be more, much more; the total value of all services buyable via bitcoin if it reaches wide adoption. I think the chances of that are slim, maybe 1% is fair.

I think Bitcoin is virtually certain (barring some fatal flaw in the technology) to become *the* micro payment currency; kind of what flattr is trying to do.

Snizz April 26, 2011 at 10:37 am

I’m going to put a few thousand dollars in and see where it goes. I feel like a moron sitting on the sidelines. The buzz is just now starting to build, so there should be quite a run in this yet.

Dan Weber April 26, 2011 at 12:46 pm

For some reason your comment on the housing bubble got delayed by several years and posted in this article instead.

mobile April 26, 2011 at 11:00 am

Isn’t every fiat currency a bubble?

Levi Ramsey April 26, 2011 at 2:29 pm

Isn’t every currency a bubble?

(has gold ever traded anywhere near its intrinsic (i.e. industrial) value?)

Karl April 26, 2011 at 11:04 am

I remember in February when Slashdot (website with major tech following) covered the news on bitcoins passing $1.

The exchange rate had just doubled over the previous handful of days, and that level had seen a quadrupling from the price it was at right before Christmas.

There were so many screams of “bubble!, run, run away!” And yes, for a number of weeks, the price dropped — by over a third at one point.

But then you read up and see all the ways people are talking about using bitcoins. All the doors that Bitcoin opens for them. Bitcoin is becoming a lab where innovative ideas from around the world are becoming prototypes, and where prototypes are becoming products.

BItcoin is a community where these geeks feel free to try something just friggin crazy. Instead of getting shot down by their boss they are get help and guidance from their peers instead.

Well, the exchange rate is significantly higher than parity with the dollar now, And significantly higher than parity with the Euro even. Oh, and just checking — it is over parity with the Pound Sterling at the moment as well.

And don’t forget … that increase has occurred with full knowledge that there is dilution built-in — about 0.12% per day (roughly 7200 bitcoins are minted daily at the current levels). Though unlike with other commodities, currencies or equities, the exact number of bitcoins minted two years out and ten years out, is known today.

You can benefit from the success of these people’s ideas by speculating in bitcoins while the “per share” price is $1.70 or you can wait until it is $5 or whatever, if you prefer. Or go short if you don’t believe in its success. There’s no shortage of people who would pay a pretty premium to have the option to buy a year from now at today’s valuations.

Corporate Serf April 26, 2011 at 1:53 pm

I am curious.
Is there any de facto venue where bitCoins are traded?

M. Dutton April 26, 2011 at 7:10 pm

The main market is BCUSD at:
https://mtgox.com/

You can track the markets for several currencies at:
http://bitcoincharts.com/markets/

M. Dutton April 26, 2011 at 7:10 pm

That should say <–>

Brock Tice April 26, 2011 at 12:41 pm

Tyler,

I took issue with the title of this post, which is being tweeted about, and it was suggested that I point it out directly to you, so here it goes:

Bitcoin cannot “be” a bubble any more than a house can “be” a bubble. Perhaps what you meant by your title is, “Is bitcoin’s value relative to the dollar experiencing a bubble?”.

I think it’s important to state things this way because otherwise you are implying that bitcoin itself is somehow a bubble, that once the bubble ‘bursts’ there will be no bitcoins, but that’s like saying that when the housing bubble burst, houses ceased to exist. In fact, they did not. They still exist, they still have value. Some people got burned, but the housing market goes on, for better or for worse. In fact the housing bubble was even worse, because it was founded on borrowed money. As far as I know this is not the case for bitcoins. Likewise whether the value drops significantly, assuming no technical weaknesses are found bitcoins will still exist and still have uses and value.

I used to read this blog quite a bit and I respect you and what you have to say a lot. I’m interested in your economic views on bitcoin but unfortunately, at least in your first bitcoin post, they seemed to be founded on a very superficial understanding of what bitcoins are and how they are used. Nonetheless, thank you for contributing to the discussion.

Dan Weber April 26, 2011 at 12:49 pm

The vast majority (perhaps all) of the vendors accepting Bitcoins do so because they can be converted to their local currency. In fact, one vendor I check regularly basically lets you pay in dollars or pay in Bitcoins, and the amount of Bitcoins he wants has dropped exactly in proportion to their dollar value. If Bitcoins plummet in value, he will demand more.

At least I could live in a house. If Bitcoins are a bubble and they burst, my Bitcoins will be no better than rubles.

Brock Tice April 26, 2011 at 12:56 pm

Dan, what you say is certainly correct, except one thing, you are abusing english just as in the title of this post. “Bitcoins are a bubble” verges on nonsense. The value of bitcoins could be experiencing a bubble.

Rahul April 26, 2011 at 1:41 pm

That’s just semantics.

Brock Tice April 26, 2011 at 2:39 pm

You may think I’m pompous, actually I’m pedantic. Let me explain the difference.

Dominic Sayers May 19, 2011 at 9:16 am

This seems to be pretty much what happens in 3rd world countries (in my limited travel experience). The local currency tends to be volatile and there is a black market in USD. Those countries whose economies have developed and matured now have much more stable local currencies and a less significant USD black market.

Looked at from this perspective, BitCoins are the local currency of a still tiny economy and there is a vast black market in government-issued currencies. The BitCoin economy could collapse or it could mature, but at least we know what the policies of its central bank will be.

FreeMoney April 26, 2011 at 12:51 pm

Is there an option for a bitcoin–to-dollars conversion service offered by someone? What’s the commission.

coincard.ndrix.com is probably the best and easiest. $1 + 1.25% fee

koin April 26, 2011 at 12:59 pm

Plenty of ways to convert bitcoins to dollars:
http://en.bitcoin.it/wiki/Selling_bitcoins

Mt. Gox charges 0.65% when you convert your bitcoins to USD. Then withdrawal as an ACH yto your bank account ($800 or more) is free of charge.

Ellie K April 26, 2011 at 5:12 pm

I often confuse Tyler Durden with Tyler Cowen. Which means that I have to remind myself that MarginalEvolution is not part of the @ZeroHedge family. The topic of bitcoin is somewhat Zerohedge-esque, however.

Two thoughts about bitcoin, after reading this post, plus an article about bitcoin on http://techliberation.com that references this post, then viewing the http://weusecarrots.com and http://weusecoins.com websites. The latter describes itself as “Your Portal into the World of Bitcoin”. Both my thoughts are kind of negative. The first is fear of fraud. Is there any reason to trust bitcoin transactions without a clearinghouse (like PayPal)? What is the fraud exposure resulting from the open source status of many (all?) bitcoin infrastructure and applications? My inquiry about fraud potential is not meant sarcastically or rhetorically. Is there any protection against fraud with bitcoin transactions? Is it safe?

This is a separate matter from trading in bitcoins as a speculator in currency, of course. But it is related, because trust and some faith is necessary for the bitcoin market to succeed, and if that isn’t there, it may not even make sense as a short position. That’s silly anyway, because you’d need an entire futures and options market to create itself in order to execute any short transaction, and that requires all the things that bitcoin advocates are trying to get away from, I’m guessing.

Second thought: A good use for bitcoin would be for buying music online. I thought that was already happening. Yet I noticed the following while doing a quick search for #bitcoin on Twitter. It is purely hearsay and I haven’t validated, but if true, indicates that bitcoin is still developing as a medium of exchange: https://twitter.com/#!/saddet/status/62933503171493888

Dan Weber April 26, 2011 at 5:57 pm

If your computer is secure, then bitcoins stored on it are secure. As long as no one can break the encryption, which is very difficult. (If someone could break it, they’d probably break into banks instead.)

The most likely fraud is that someone will give you a coin that they also spent someplace else. This will show up on the network, however. Someone could try to control a lot of nodes to repudiate his double-spending, but for small transactions this would be silly.

Sending someone bitcoins is like sending them cash. You can’t undo it (although you could try to double-spend the coin, I guess). If you buy something online with bitcoins, the vendor could just decline to send the stuff to you, and you can’t go to the credit card company to fight back.

Bitcoin transactions also aren’t instantaneous; they may take several minutes (up to an hour) to propagate across the network and be confirmed.

Bitcoin clearinghouses can address these last two problems, but honestly there’s nothing that can deal with situations where the buyer and seller don’t trust each other. Even with credit cards, someone has to be left holding the bag.

Ellie K April 27, 2011 at 1:49 am

Thank you. I need to think through what you said. I appreciate that you took the time to help me.

zby April 30, 2011 at 10:36 am

If you compare bitcoin as a payment mechanism to say PayPal – then a market cap of a billion dollars would not be that unreasonable – and that is only for the payment mechanism part of it, disregarding the whole value store part of it. Of course the question if the bitcoin infrastructure can support payments on the scale of PayPal is open.

Meng Bomin April 27, 2011 at 1:03 am

I’d like to report some obvious spam

Ellie K April 27, 2011 at 1:48 am

The prior verbiage is spam! Please heed @Meng Bomin earlier report of such and remove this very obvious spam. It is an affront to the fine content of the original post on the bitcoin currency, and to the comment thread that follows. Thank you.

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