How and why Bitcoin will plummet in price

by on December 30, 2013 at 7:49 am in Economics | Permalink

My post from yesterday was perhaps not specific enough, so let me outline one possible scenario in which the value of Bitcoin (and other cryptocurrencies) would fall apart.  For purposes of argument, let’s say that a year from now Bitcoin is priced at $500.  Then you want some Bitcoin, let’s say to buy some drugs.  And you find someone willing to sell you Bitcoin for about $500.

But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400.  Will you ever accept such an offer?  Well, QuitCoin is “cheaper,” but of course it may buy you less on the other side of the transaction as well.  The QuitCoin merchants realize this, and so they have built deflationary pressures into the algorithm, so you expect QuitCoin to rise in value over time, enough to make you want to hold it.  So you buy some newly minted QuitCoin for $400, and its price springs up pretty quickly,  at which point you buy the drugs with it.  (Note that the cryptocurrency creators will, for reasons of profit maximization, exempt themselves from upfront mining costs and thus reap initial seigniorage, which will be some fraction of the total new value they create, and make a market by sharing some of that seigniorage with early adopters.)

Let’s say it costs the QuitCoin company $50 in per unit marketing costs for each arbitrage of this nature.  (Alternatively you can think of that sum as representing the natural monopoly reserve currency advantage of Bitcoin.)  In that case both the company and the buyers of QuitCoin are better off at the initial transfer price of $400 and people will prefer that new medium.  Over time the price of Bitcoin will have to fall to about $450 in response to competition.

But of course the story doesn’t end there.  Along comes SpitCoin, offering to sell you some payment media for $300.  Rat-FacedGitCoin offers you a deal for $200.  ZitCoin is cheaper yet.  And so on.

Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors.  And so are the available rents on the supply-side exhausted.

There is thus a new theorem: the value of WitCoin should, in equilibrium, be equal to the marketing costs of its potential competitors.

This theorem will hold even if you are very optimistic about market demand and think that grannies will get in on it.  In fact the larger the network of demanders, the lower the marginal marketing cost may be — a bit like cellphones — and that means even lower valuations for the dominant cryptocurrency.

(It is an interesting question what fixed, marginal, and average cost look like here.  Arguably market participants will not accept any cryptocurrency which is not ultimately and credibly fixed in supply, so for a given cryptocurrency the marginal cost of marketing more at some point becomes infinite.  Marginal cost of supply for the market as a whole is perhaps the (mostly) fixed cost of setting up a new cryptocurrency-generating firm, which issues blocks of cryptocurrency, and that we can think of as roughly constant as the total supply of cryptocurrency expands through further entry.  In any case this issue deserves further consideration.)

Note that the more “optimistic” you are about Bitcoin, presumably you should also be more optimistic about its future competitors too.  Which means the theorem will kick in and you should be a bear on Bitcoin price.  Arguably it’s the bears on the general workability of cryptocurrencies who should be bullish on Bitcoin price because a) we know Bitcoin already exists, and b) we would have to consider that existence an unexpected and unreplicable outlier of some sort.  Yet the usual demon of mood affiliation denies us such a consistency of reasoning, and the cryptocurrency bulls are often also bulls on Bitcoin price, as too many of us prefer a consistency of mood!

In theory

Now, theoretically, you might believe that the current price of Bitcoin already reflects exactly those marketing costs of potential competitors and thus the current equilibrium is stable or semi-stable.  Maybe so, but I doubt that.  The current value of outstanding Bitcoin is about $20 billion or so, and it doesn’t seem it cost nearly that much to launch the idea.  And now that we know cryptocurrencies can in some way “work,” it seems marketing a competitor might be easier yet.  (You will note that by its nature, there are some Bitcoin imperfections permanently built into the system, imperfections which a competitor could improve upon.  Furthermore the longer Bitcoin stays in the public eye, the more likely that an established institution will label its new and improved product LegitCoin and give it a big boost.)

You can think of that $20 billion — or perhaps just some chunk of that? — as a very rough measure of the prize to be won if you can come up with a successful Bitcoin competitor.  Even a fraction of that sum will spur some real effort.

In short, we are still in a situation where supply-side arbitrage has not worked its way through the value of Bitcoin.  And that is one reason — among others — why I expect the value of Bitcoin to fall — a lot.

I thank Brad DeLong for an email query and analysis which sparked this blog post.

Addendum: Maybe I’ll write another post on the possible expected deflationary bias in any cryptocurrency, given that expected price changes usually get compressed into the present and that an overall expected rate of return equality must hold.  And the question of how much an initial issuer can exempt itself from mining costs as a form of reaping upfront seigniorage. and the profit-maximizing way of sharing these gains with early adopters.  Those are two hanging issues with respect to the analysis here, in addition to the matter of cost structure discussed in the parentheses above.  And now go reread Kareken and Wallace (1981).  “=/∞” I think one has to say here.

Finder Keeper December 30, 2013 at 8:04 am

These competitors aren’t just potential ones – there are already dozens of real competing cryptocurrencies (chiefly litecoin) that enjoy varying degrees of acceptance. So why does bitcoin still retain its value? Because of its first mover advantage and network effect. Why would merchants, exchanges and payment processors (like bitpay and coinbase) support a newer coin when bitcoin is already so well established?

mofo. December 30, 2013 at 9:10 am

So if you are correct, then TC’s statement:

“Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors.”

Should actually be:

“Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors + the value of its first mover advantage and network effect.”

Is that correct?

Finder Keeper December 30, 2013 at 9:20 am

Yes, that would seem to be the asymptotic value. In the short term, hype, speculation, “irrational exuberance” etc will also contribute to the market price. All of these things (including the first mover advantage and network effect) keep changing over time and are tricky to assign a dollar value to. I suppose the school of thought that says that the value of something is whatever the market will pay probably applies here. That’s why a litecoin is worth only a small fraction of a bitcoin.

Ray Lopez December 30, 2013 at 1:04 pm

In defense of TC’s thesis, Litecoin is not a fixed supply, like Bitcoin, but potentially infinite (though Litecoin costs money to mine, in terms of electricity consumed), sort of like Silver vs Gold in the physical metal market.

Alec December 30, 2013 at 2:06 pm

I believe Litecoin is like Bitcoin in that it has a limited total supply of units.

From the Wiki:
“The Litecoin network will produce 84 million litecoins, or four times as many currency units as will be issued by the Bitcoin network.”

Though I am sure there are altcoins that fit your description.

The Corrector December 30, 2013 at 8:39 pm

How did you come up with that? Litecoin supply is infinite?
I don’t hope anybody is stupid enough to take your word for that.

Alex K. December 30, 2013 at 3:49 pm

““Once the market becomes contestable, it seems the price of the dominant cryptocurrency is set at about $50, or the marketing costs faced by its potential competitors + the value of its first mover advantage and network effect.”
Is that correct?”

I think Tyler C. is wrong about this.

Barriers to entry, like network effects, are simply NOT something that you can buy off. In particular, marketing cost is not a barrier to entry. Tyler goes on to analyze the situation as if there is no distinction between marketing costs and barriers to entry but he is just making a category error.

That’s not to say that BitCoin will survive for ever. But if it falls it will not be because of competitors — it will probably be because of a government shut-down coupled with the fact that all its value comes from expectations of illegitimate uses plus naivety.

Z December 31, 2013 at 8:25 am

I disagree a bit. Bitcoin exists because it competes with state issued currency. If dollars and euros were suitable for the purpose of buying heroin or AK-47’s, there would be no need for Bitcoin. It is this fact that will be the undoing of all of these currencies. The US government is not ceding control of the money supply to Bitcoin. As soon as they think it is a threat, they take it out and that’s the end of Bitcoin. The tax code is all they need.

That’s the frustration I have with “disruptive technology” arguments. They too often assume the guys being disrupted will acquiesce without a fight. Reality tells a different story. Often, the established order wins. It’s why I think Bitcoin is just a clever reinterpretation of the Pet Rock. P.T. Barnum is laughing right now.

Craig December 31, 2013 at 9:46 am

Dollars are wonderfully suitable for buying heroin and AK-47s, which is why you will find such sales transacted in dollars around the world, cash on the barrel.

Online sales of heroin, however, are trickier, because online transactions lack the anonymity of physical cash. A big part of the appeal of Bitcoin is that it is thought to be anonymous–I say “thought,” because, in fact, the anonymity of Bitcoin has been wildly oversold. Everyone gets a copy of every Bitcoin transaction in the history of the Universe–the “block chain”–and only has to solve the puzzle of linking wallet numbers to individuals. That’s such an interesting and stimulating puzzle that I bet the NSA doesn’t even have to pay their cryptographers to work on it–they do it for free in the evenings.

See for more on this, under “How anonymous is Bitcoin?” But the bottom line is, anyone who uses Bitcoin is leaving a public transaction record that never goes away.

I’ll keep buying my heroin with cash dollars, thank you, pulled from the ATM while wearing gloves…

Z December 31, 2013 at 10:23 am


I don’t disagree. The point I’m making is the morons using Bitcoin to buy banned products *think* it is better than greenbacks. The reason it exists is enough people believe it has utility. The reason it has rocketed in value is a larger number of people think they can get out before everyone figures out that Bitcoin means “tulip bulbs” in another language.

Mike Germaine December 30, 2013 at 9:59 am

Additionally, I think Cowen is underestimating the value of the approximately 10 petahashes of computing power that is currently securing the bitcoin network. Quitcoin, spitcoin, and zitcoin don’t have this. So while it may be easy to copy bitcoin, and maybe easy to get a few people to use the altcoins via savvy marketing, there is a huge barrier to overcome in terms of reaching the same level of security necessary to resist 51% attacks, for example.

Stephen Gornick December 30, 2013 at 10:49 am


I just posted below with an identical argument. The difference is nearly entirely in the level of risk you are exposed to.

NK December 30, 2013 at 9:44 pm

I’d argue it’s less risky to own some (or several) small coins than bitcoin.

Rahul December 30, 2013 at 1:59 pm

How flexible is the computing power? Is that tied to Bitcoin or can it be fairly cheaply re-purposed to mine other currencies.

Kit Sunde December 30, 2013 at 7:27 pm

The new generation of ASIC miners will be repurposed as $15,000 doorstops a few short months after hitting the market and becoming useless, all the old now obsolete FGPA’s, GPU’s and dedicated-computers can be put to other uses.

Alex December 31, 2013 at 7:18 pm

Not entirely true: ASIC miners can mine any of the altcoins that use SH256 encryption, which as I understand it is more than half the ones out there. They cannot be used to mine litecoin, or any other coin based on Scrypt encryption.

Furthermore, an ASIC miner is capable of mining all the SH256 coins simultaneously without any noticeable loss in its hash rate, by having the computer it’s connected to send the hashes to all the different coin networks simultaneously (the bandwidth requirements for SH256 hashing are negligible).

aepxc December 31, 2013 at 2:09 am

>>Why would merchants, exchanges and payment processors (like bitpay and coinbase) support a newer coin when bitcoin is already so well established?<<

That would depend on the cost of supporting a new cryptocurrency. If the cost is negligible in the long run (and I see no technical reasons why it would not be), why would anyone not accept any sufficently liquid currency? And liquidity popularity marketing costs (since cryptocurrencies have no inherent value).

Arial January 1, 2014 at 4:00 pm

That answer is basic……cost.

ahduth December 30, 2013 at 8:05 am

This makes a quite a bit of sense, I hadn’t considered the seigniorage/marketing cost considerations in determining where (or whether) there might be a floor for this type of asset.

Are you able to post DeLong’s inquiry?

liberalarts December 30, 2013 at 8:06 am

How much does this analysis depend on Bitcoin being used as a medium of exchange for Bitcoin priced transactions? As I see it, it is only a transactions medium as a novelty and only is used with dollar prices and market exchange rates. Thus the idea of a fixed Bitcoin quantity for a transaction is not in place for the equilibrating process to occur.

ahduth December 30, 2013 at 8:13 am

For normal market transactions, I think everyone will agree that bitcoin is entirely useless as a measure of value.

As Cowen points out however, it is very popular in illicit markets, where untraceability trumps price stability as a primary feature you’re looking for in a currency.

Cyrus December 30, 2013 at 9:06 am

Even the illicit business uses a national currency for accounting while using Bitcoin as a medium of exchange.

john personna December 30, 2013 at 10:41 am

Thus Bitcoin acts as a cool-kids PayPal.

David January 17, 2014 at 2:39 am

cool-kids who don’t have to pay PayPal transaction fees.

William December 30, 2013 at 8:08 am

What you outline here is a future in which the value of Bitcoin is stable and it actually becomes workable as a currency, albeit a low volume one. The Bitcoin designers might call that success, even if the speculators / investors don’t.

RPLong December 30, 2013 at 8:57 am

My thoughts exactly.

Rahul December 30, 2013 at 9:36 am

Is there a way to short Bitcoin? If one is sufficiently confident can one monetize his skepticism?

Clinton Weir December 30, 2013 at 12:58 pm

Sure, you can short ANY commodity. But if you have to ask this question I recommend you don’t.

To short bitcoin: find someone who has Bitcoins and is willing to lend them to you against a promise to repay him in bitcoins. Borrow and sell those bitcoins. Then when the dollar value of a bitcoin falls, buy some and give them to your lender to settle the debt.

Ray Lopez December 30, 2013 at 1:07 pm

Rahul’s question is good: given that bitcoin is not recognized as legitimate, it will be hard to enforce a contract to short bitcoin unless the parties meet in person and draft a contract that both sign…since most people don’t do that, and instead rely on electronic exchanges and ‘clickware’ type contracts, I doubt a contract to short Bitcoins is enforceable in most jurisdictions.

Computer Scientist December 30, 2013 at 3:22 pm

Use a smart contract. It is a cryptocurrency, you know, so old fashioned paper contracts are a little strange to reference.

Hazel Meade December 31, 2013 at 12:42 pm

Set up a bit-coin based website.
Rate borrowers on their repayment rates.

prior_approval December 30, 2013 at 8:16 am

Maybe Bitcoin will be replaced by cigarettes? – and the Germans even have a word for it, Zahlungsmittel, as compared to Währung.

Such a simple distinction, and yet one that really does not exist is common usage in English.

Just a short overview –

Alex Godofsky December 30, 2013 at 8:36 am

It doesn’t make the least bit of sense to talk about introducing a competitor at $400. The absolute price of a single Bitcoin is meaningless; nothing is priced in Bitcoin.

joshua December 30, 2013 at 8:44 am

I don’t get this either. If BTC is $500 and ‘QTC’ is $400 why would someone prefer 1.0 ‘QTC’ to 0.8 ‘BTC’? I may be missing something with this particular critique, but it does seem in general that a lot of armchair-Bitcoin-dismissal comes from not understanding how divisible they are.

Alistair Cunningham December 30, 2013 at 8:47 am

I get the impression that the point is that the QTC developers have deliberately made their currency more inflationary than BTC in order to attract hoarders, so the price of QTC is expected to rise faster than that of BTC. Correct me if I’m wrong…

Alistair Cunningham December 30, 2013 at 8:47 am

Sorry, “more deflationary” rather than “more inflationary”.

Alex Godofsky December 30, 2013 at 9:25 am

Yeah, but you can’t actually do that. The deflationary behavior is contingent on people actually adopting the currency.

Tyler is somehow missing the huge network effect.

Alistair Cunningham December 30, 2013 at 9:37 am

I would tend to agree with this assessment.

john personna December 30, 2013 at 11:21 am

I certainly accept the network effect, but remember that network effects in the Internet domain can be fickle. Some, like eBay or Amazon abide, while some, like Myspace or AOL faded. (I guess it is a challenge, for me the skeptic, to suggest that BitCoin might be like eBay. That is sure anyone “could” do it. We’ll see though, perhaps the 2nd entrants were too fast on its heels … *before* Bitcoin was accepted at the local storefront.)

john personna December 30, 2013 at 11:26 am

Hmm. Despite Bitcoin boosters not wanting to talk about PayPal, it is actually PayPal which has the network effects among actual shoppers and (internet) storefronts.

(PayPal is mostly a US thing, but Africa has a pay-by-cellphone thing that has grown massively before Bitcoin.)

Eliezer Yudkowsky December 31, 2013 at 7:46 pm

I came here to say the same. Unless I’m missing something, the OP is complete gibberish and I can’t imagine what on Earth Tyler was thinking. There isn’t a rule saying that one coin purchases a fixed amount of drugs and different people competing to sell you a coin. E-currencies are a medium of exchange, not a medium of account, and my decision to use one e-currency over another is going to have *nothing whatsoever* to do with their nominal price per arbitrary unit in USD!

Eliezer Yudkowsky December 31, 2013 at 7:49 pm

I see that yesterday Tyler wrote, “Competing suppliers make a run for the available rents, and the supply of such cryptocurrencies as a whole does not have an obvious limit.” This makes sense, but today’s post, talking about nominal price declines driven by nominal price competition, did not make sense to me at all.

themusicgod1 December 30, 2013 at 9:57 am

So many misconceptions in this thread it’s hard to know where to start. How about here. There is probably a hundred thousand businesses at least accepting bitcoin, pricing their products *to some degree* in bitcoin. Sure many use payment processors and have local currency fixed and marginal costs, but to an increasing extent, their prices represent the cost of doing business *in bitcoin* and this proportion will continue to increase with time, assuming bitcoin can consolidate its gains in the consumer market into gains into the suppliers of those companies.

john personna December 30, 2013 at 11:28 am

Watch out, I might be counted as one of those hundred thousand, because I had to open up a Coinbase account as part of my MOOC.

Dave December 30, 2013 at 1:51 pm

In regards to your comment on Facebook vs Myspace, don’t forget that we’re not talking about websites, we talking about a protocol.

The real question is “What was the competitor to TCP/IP back in the day?” That’s what Facebook, Myspace, eBay, this website all run on. Bitcoin is a protocol first and foremost. Eventually this will be understood by more people. For now all anyone ever talks about is Bitcoin-the-currency which is “burying the lead” if yo will.

MOOCER December 31, 2013 at 11:59 am

Coinbase account for a MOOC ? How so, sir ?

Ben Roth January 5, 2014 at 11:06 am

Exactly. This post was nonsensical. In fact, the opposite is true. Bitcoin supply is ultimately finite and the rate of increase in supply is decreasing even as the rate of the Bitcoin economy is expanding. This is what’s causing the rapid increase in value of bitcoins (deflation). The up/down swings are due to the uncertainty rapid change causes. The downfall of bitcoin will be when the economy using it gets so ridiculously big that even 1 in the last decimal place will be too valuable to buy some cheap things in the small quantities people want.

The coin that manages to beat out bitcoin will be one that figures out how to make decimal places extensible so that there is no fixed constraint on the minimum transaction size.

Rassah January 12, 2014 at 2:43 am

Bitcoin decimal places are already extensible.

Alistair Cunningham December 30, 2013 at 8:38 am

Of course, Bitcoin itself is deflationary, so when you say “QuitCoin merchants realize this, and so they have built deflationary pressures into the algorithm”, presumably you mean that the QuitCoin developers have deliberately made their currency MORE deflationary than Bitcoin to make it more attractive to speculators? Presumably this will lead to a race-to-the-bottom of ever more deflationary currencies, with more and more market fragmentation between them? Presumably the end result is multiple cryptocurrencies in use, with differing tradeoffs between credibility (good for those who want a currency as a means of exchange) and deflation (good for speculators and hoarders)? If so, I wonder whether this will take the form of a bifurcation, or a broad spectrum?

Explodicle December 30, 2013 at 12:23 pm

This already happened with Ixcoin and I0coin.

Ixcoin was released as a copy of Bitcoin, except the full supply is released in years instead of decades. It includes a large “pre-mine” for seigniorage. They were trying to capitalize on people who “missed the boat” with Bitcoin and wanted to get rich quick off something even more deflationary.

I0coin is a copy of Ixcoin, except with no pre-mine. They were trying to cash into the market Ixcoin created, starting a race to the bottom.

In the years since then, there have been dozens of competing cryptocurrencies launched, including Litecoin. One of the common features between the successful coins is a lack of seigniorage, since anyone can just strip out the seigniorage from the source code and launch a competitor.

In practice, what appears to be happening (IMHO) is that investors attribute much more value to Bitcoin’s network effect – you can buy plenty of things denominated in BTC without having to convert currencies. The rate of inflation in Bitcoin is already so low that switching costs are much higher than deflation opportunity costs.

Rahul December 30, 2013 at 2:06 pm

Are all the cryptocurrencies based on a proof of work core? Just wondering is there are any alternatives that do not need proof of work.

Explodicle December 30, 2013 at 7:44 pm

Another popular alternative is “proof of stake”, for example with Peercoin.

Jon Teets December 30, 2013 at 9:10 am

Here is a list of the market caps and other interesting stats for many crypto-currencies:

Don’t blink. This list itself is somewhat volatile.

Altcoins are not competing on the basis of price (yet). It is doubtful that they will in the short term, as there is a vast feature space to explore. It’s doubtful they will in the long term, either. Fundamentally, Bitcoin the protocol is a network platform. The appropriate analogy for altcoins isn’t the competition between three search engines, but the co-existence of gmail, amazon and x-box live.

The innovation here isn’t that money can now be tracked over a network in a trust-worthy or perhaps anonymous way, or that it can zip past capital controls and avoid bank fees and maybe simulate gold, or even strike a blow to the man or for this or that ideology; it’s that the money in everyone’s pocket and bank account can now be an executable program.

Is Bitcoin itself going to survive? I don’t know, but I doubt that if it fails, it will be on the basis of price. It is much more likely that one or more governments will realize that money as software means that they can roll their own crypto-currency and control to an arbitrary level of granularity how and when, etc. the money they disburse is spent or how any money spent is taxed, for that matter, and can track all said expenditures instantly as they occur. That the peer-to-peer network does this for them for “free” and that most of the software to handle all the plumbing will also come for free is just a bonus.

IMHO, the show here is that increasingly, the money you have will come with strings attached. I’m not confident that existing monetary theory is developed enough to account for this.

Dallas December 31, 2013 at 2:32 am

Great points here John – I think you’ve raised a very likely competitor to bitcoin : national bitcoin protocols, perhaps only able to be mined by the state or under certain circumstances.
These could still be traded on a forex and have a “standard” value. Over time “normal” fiat could be exchanged for countrycoin until there was only countrycoin left.

I’m certain that what we use for money in 5 years will look more like bitcoin than like banknotes. Open source is just ironing out the kinks for free – governments are hopeless at this (witness the Obamacare website.

Ray Blaak January 1, 2014 at 3:12 pm

Is that what Canada’s effort is likely about?

James O'Beirne December 30, 2013 at 9:10 am

Thanks for the article. I’m curious, though: are you taking into account (i) network effects and (ii) the relative value of BTC’s existing infrastructure?

Regarding (i), spinning up new currencies that folks will actually consider using to buy goods and services (as opposed to speculation, c.f. dogecoin) seems impractical in short periods of time (say, less than a few months). Merchants and consumers will have to acquaint themselves with these currencies, which doesn’t happen overnight. Third-party integrations that already exist for Bitcoin (e.g. won’t exist for younger cryptocurrencies, which I don’t think you’re accounting for.

The more compelling point here, though, is (ii): Bitcoin’s relatively large infrastructure of miners (i.e. machines that enable transactions to be added to the blockchain) presents a considerable advantage over nascent competitors. The amount of horsepower that undergirds the BTC system to enable a high volume of transactions to be processed reasonably quickly developed over *years*. I haven’t seen characteristics in any competing cryptocurrency (e.g. Litecoin, Dogecoin) that would make jumping ship and abandoning that infrastructure worthwhile in the long run. I suspect that consumers and merchants who are, in the first place, savvy enough to be pioneering cryptocurrency will realize this.

Bitcoin’s downfall will happen if and when a severe Achilles’ heel is discovered in the protocol, and another currency swoops in with a remedy. At present, I’m unconvinced that such a flaw has been discovered.

Ray Lopez December 30, 2013 at 1:16 pm

One Achilles’ heel of bitcoin is the large block chain that already measures in the GB size I believe. Whatever the actual size is (I can Google it but am too lazy) the informed opinion seems to be that eventually, in a few years time if bitcoin continues to grow in popularity, and to save time (already it is taking about 20 minutes or more to ‘verify’ a bitcoin transaction) the blockchain will move “offline” and bitcoin transactions will be ‘verified’ by a central depository, a “bank” if you will, rather than point to point between the buyer and seller, as at present. When and if this happens, it will defeat somewhat the purpose of having bitcoin, namely, that it can exist without trusting a central bank.

Dave December 30, 2013 at 2:03 pm

A few corrections:

On average it takes about 10 minutes for a confirmation. This hasn’t changed in 5 years.

The blockchain ledger is around 12 GB (I think), which is big, but not remotely that big in the grand scheme of things.

You don’t need a personal copy of the blockchain to use bitcoin, there are lots of online/light wallets that don’t use it. True, the transaction will have to propogate through the blockchain, but the network of full blockchain nodes is so vast that this won’t be a problem, especially when one considers how rapidly the cost of storage comes down on a yearly basis.

A central bank type of system is something I’m not familiar with. I think you mean offline transactions that use a hub & spoke type of system. This can be very useful, and though it would represent a certain measure of centralization in a localized area (eg. remote part of Africa) the hub will eventually have to resync with the rest of the network. But at no point will the entire Bitcoin network become centralized, not any more than all servers in the world will be centralized into one massive Uber-Server located in an underground complex in Siberia.

J81 December 30, 2013 at 9:14 am

Few remarks:

1) We write Bitcoin not BitCoin.

2) Like every softwares, services, programs, developers are still working and improving the bitcoin protocol. The argument that said that the alt-coins can take fully advantage of the btc flaws has to be mitigated.

3) This new currency that mixed the fundamental of fiat currency and gold (and the peer to peer network as well) forced us to change the way we thing about money. In the new economy, you cannot explained everything only by the law of offer and demand, you have to think about building communities and network.

For example, if you want, in few weeks you can create a new facebook network. Will it work ? certainly not, you’ll just have in your hand an empty city because the harder has to be done : convinced people to use it while there is none of your friend in it.

Destroying the bitcoin and it’s value simply by multiplying the number of altcoins doesn’t work. While everybody can simply copy-paste the opensourced code, what they can’t replicated easily is the community. Right now there is many investorand entrepreneur around the globe putting their money on the table to create services and momentum around bitcoin. Can we say the same for the other alt-coin? no. What drives the value of an alt-currency is not only its scarcity or security, but it’s more than anything its nerwork.

Nick December 30, 2013 at 12:42 pm

For example, if you want, in few weeks you can create a new geocities^H^H^H^H^H^H^H^H^HFriendster^H^H^H^H^H^H^H^H^H^HMySpace^H^H^H^H^H^H^Hfacebook network. Will it work ? certainly not,


Nylund December 31, 2013 at 10:25 am

And twitter, instagram, snapchat, etc. It seems to me that creating new networks has never been easier. Sure, there are still network effects, but they don’t seem to be the barrier to entry they once were.

The secret to creating new networks quickly is often to fill the desire of a subgroup that specifically wants a separate network. Teenagers (who want to avoid the prying eyes of parents), and adult content have been huge drivers in the past. In Bitcoin’s case, one aspect of that separate network that helped adoption was the Silk Road and those sorts of black markets.

If Bitcoin became widely used then governments would get involved (and they already are, or trying to). That then creates a desire for the Silk Road types to move to a new network that is more separated from the government. In effect, I think that as long as the buyers and sellers of the type that use Silk Road exist, there will always be the potential for a new cryptocurrency network to emerge.

Hazel Meade December 31, 2013 at 12:49 pm

You mean as long as drugs are illegal, there will be a market for an alternate crypto-currency the government isn’t tracking yet.

potential seer December 30, 2013 at 9:18 am

This analysis seems to miss the point. It is clear that if bitcoin is not widely considered to be very distinct from Quitcoin (or other competitors like today’s Peercoin) then its value will go to 0. However, this same argument is also true about, say, the Euro (or US$ or …). People trust the European union enough as to want to hold Euros more than they want to hold any money that I will choose to print even though, in principle, it competes with the Euro just like quitcoin competes with bitcoin. The question is whether the trust in the network of bitcoins can grow to be as strong as the trust in the Euro or US$. It is not clear that such trust in the “network” of bitcoin-believers is inherently weaker than the trust in the network of Euro-believers.

Max December 30, 2013 at 10:20 am

Why would anyone rational hold their wealth – even a tiny amount – in the form of a bubble when there is any alternative?

If there’s no rational basis for the value of bitcoin, then it’s not any different from a pump-and-dump stock scam. It depends on a flow of suckers to sustain it, and when the supply of suckers dries up, the value collapses – and eventually goes to zero. Even if people are getting utility from the scam – maybe they enjoy gambling – that doesn’t prevent it from going to zero. Zero is the equilibrium.

MD2 December 30, 2013 at 1:05 pm

It depends on a flow of suckers to sustain it, and when the supply of suckers dries up, the value collapses – and eventually goes to zero. Even if people are getting utility from the scam – maybe they enjoy gambling – that doesn’t prevent it from going to zero. Zero is the equilibrium.

Were you talking about bitcoins or dollars?

Ray Lopez December 30, 2013 at 1:26 pm

@MD2 (MD2 hashes? lol)- you are so right.

A while ago–I believe it was about 25 years ago–the Economist magazine had a survey, about 30 pages long (they used to have longer surveys than now) about DeBeers and its predicted demise. Besides the usual punny and sarcastic captions, such as a loving couple exchanging a diamond ring with the caption “We’re here for De Beers”, the article concluded that DeBeers is going to soon collapse since as a cartel, even a vertically integrated cartel (which is much harder to defeat than a horizontal cartel like OPEC), they are doomed according to economic academic theory. Of course the theory is right–but DeBeers is still standing, since, as Keynes himself noted: ‘ The market can stay irrational longer than you can stay solvent’.

Yes bitcoin is a fad, yes it will fail, yes it will go towards zero, if not zero, yes it is unsustainable, but then again so is OPEC, so is DeBeers, so is arguably the current trajectory of the US government, and so was the USSR (look how long they lasted), Cuba, North Korea, the Byzantine empire (lasted 1000 years with rigid wage and price controls, and hereditary occupations), so was the Mogul empire of India, so was the Ottoman empire (the “sick man of Europe”), insert other historically failed states that hobbled on for decades here…. nuff said.

PQuincy December 31, 2013 at 12:03 am

“Were you talking about bitcoins or dollars?”

When you can pay your taxes in bitcoins, and when the government pays its contracts in bitcoins, then we can take about such an equivalence. Until then, not so much…

affenkopf December 30, 2013 at 9:18 am

Here’s Tyler’s first prediction about the demise of bitcoin. It’s from October 17, 2011 when 1 bitcoin was worth $2.80 (it’s worth $759.90 now).

bighak December 30, 2013 at 11:37 am

Yes I’d love to see Tyler mea culpa on this. Clearly Bitcoin is now much stronger now in term of merchant acceptance, market cap, liquidity, transactions, geographic diversity, etc. If he has clear realistic plan to make a btc competitors, why isnt he doing it? There is hundreds of millions of dollars to make here. I suspect the reason is that he himself understand that he doesn’t fully understand cryptocurrencies.

Jackson January 1, 2014 at 3:27 pm

Merchant acceptance? Until the day you can use them to pay your mortgage, rent, utilities, groceries, etc, don’t talk about “merchant acceptance”.

Rahul December 30, 2013 at 2:02 pm

As an aside, circa Nov 2011 Tyler was predicting imminent collapse of Greece & EU too. What’s up with that prediction?

msgkings December 30, 2013 at 3:13 pm

We’ve discussed this before, Tyler’s got a definite alarmist/doomsaying streak: Bitcoin, Europe, bird/swineflu, etc. It’s just a personality trait.

NK December 30, 2013 at 9:49 pm

To predict that Bitcoin will prosper is alarmist, so in this case he’s arguing the opposite.

HennessyHemp December 30, 2013 at 9:19 am

So there appear to be a few problems with your argument here.

First off, these competitors you speak of are already here: will give you a few to check out.
Most notably, Ripple, Litecoin, and MasterCoin. Two of these examples were not mined, and do not fit your bill, the other was
specifically built to be the Silver to Bitcoin’s gold.

Second, most people completely overlook the technology. Bitcoin has turned Moore’s Law ('s_law) into a money press.
The hardware being manufactured for Bitcoin has already been turned into the most powerful supercomputer on the planet While harnessing that power may not be in the scope
of the original project, there are coins like Primecoin capitalizing on that power (

Third, you failed to note that there is a cap of 21 Million Bitcoins (there will never be more than 21 million legitimate Bitcoins). This means as humans desire to acquire it, the price will go up ad infinitum, or until it is deemed unnecessary to humanity. Until then, you can trust in Cryptography, or you can trust in God (and the men responsible for your image of God and their paper currency they can print more of at will), either way you have to put faith in the system you chose. For Bitcoin devotees, Vires in Numeris (“Strength in Numbers”) is our battle cry, and “In Cryptography we Trust” our motto.

Kevin Saff December 30, 2013 at 11:16 am

The quantity of remaining bitcoins halves every four years. This means that the price of bitcoin must rise by at least 19%/year to keep mining as profitable as it is today. Even if bitcoin becomes earth’s sole currency it can’t continue appreciating that quickly, because world GDP grows slower than that. Therefore eventually miners will have to be increasingly rewarded with transaction fees rather than new coins. When this happens one of the primary benefits of bitcoin, low transaction costs, will be lost and a rival currency will gain traction.

dan December 30, 2013 at 11:29 am

You’re failing to account for Moore’s law. Computing power (esp. hashing based computing power) is increasing far in excess of 19% per year.

Kevin Saff December 30, 2013 at 1:07 pm

It doesn’t matter that this year’s $50 computer can hash as much as last year’s $200 computer — an attack against a total mining pool worth a million dollars is cheaper than an attack against one worth a trillion, no matter the hash rate.

Explodicle December 30, 2013 at 7:41 pm

Moore’s law doesn’t have anything to do with it because miners are competing with one another and attackers, not against a benchmark.

Eventually transaction fees WILL have to sustain the system, although this could include the transaction fees from assurance contracts designed to fund network security. We can’t assume that this “tax burden” will fall evenly on everyone.

RichardC December 31, 2013 at 8:58 am

The difficulty of Bitcoin mining is adjusted (IIRC every 2 weeks) so that vast (and
unpredicatble) increases in total computing power can be accommodated while keeping
the global rate of Bitcoin mining roughly constant at one every 10 minutes. It’s
cleverer than you think.

On the broader issues, I think Cowen vastly underestimates the network effects,
and puts way too much emphasis (as the Bitcoin inventors also did) on the
built-in shrinking of the money supply – when what is really driving the price is the
huge growth in *demand*. Which is much less predictable, and I’m pretty sure
can’t be easily manipulated by “marketing”, as he seems to believe.

Tendroid December 30, 2013 at 9:38 am

I lost you at “Then you want some Bitcoin, let’s say to buy some drugs.” Its obvious you are a clueless person when it comes to the cryptomarket. You are not engaged at all in it in any aspect so you only look it from the surface. Sorry for your loss. You missed many points along your halfwitted discussion, you clearly do not understand the infrastructure of the mining community. Im quite sure you are clueless about some of the brains and money behind crypto right now. Blah blah blah… drop the dumbass mentality about buying drugs and maybe you will sound a little bit more intelligent.

JustAHuman December 30, 2013 at 11:14 pm

Thank you.

Read elsewhere that this guy is a professor. Don’t know of what… This man alone speaks to the sad state of our educational system.

Nylund December 31, 2013 at 10:43 am

He may very well not understand all the details, and may very well be making bad points. The proper response is to prove that. Ad hominem attacks aren’t a valid logical rebuttal. No one looks smart when their argument is nothing more than name-calling.

August December 30, 2013 at 9:43 am

The very first comment is right. First mover advantage and network effect.
Meanwhile, the price of bitcoin is really mediated by whether or not it proves robust against the vagaries of the nations.
Your theoretical competitors to bitcoin have a third weakness, that of having a company offering a set price for their product.
The nature of price-setting in this way means they become public and the governments can either destroy them or compromise them.

Menachem Begin December 30, 2013 at 9:54 am

As a prediction, it’s safe because it’ll eventually come true. E.g. “That tree that is closest to your house is going to fall over.” 56 years later: “See? Told you so.”

What about the “fixed” (sic) reference of the US dollar?

nl7 December 30, 2013 at 9:56 am

I second the network effects comments, and supplement with the obvious switching costs problem. It’s at least somewhat complicated to keep switching between new currencies, even aside from networking, and it seems unlikely that non-financial customers will want to keep abreast of the varying exchange rates and the expected deflationary algorithms. Much easier to stick with a cryptocurrency that works reasonably well rather than switch to a substitute.

This also implicitly assumes that either parties have consistently mismatched time windows or that certain parties will adopt an NPV perspective while others will adopt a nominal perspective. I think most merchants will want something with a fast turnover, with no interest in holding bizarre digital currencies to maturity, and indeed lots of businesses pay for derivatives to take out the uncertainty of inflation or market shifts. Speculators may see the value in a currency that appreciates quickly, but most merchants just want a predictable value for their goods and I imagine most of them (aside from tech geeks and libertarians) who would take bitcoin would prefer to liquidate it very quickly in favor of USD. As bitcoin grows, and the proportion of ideological users shrinks, more merchants will see it as an alternative to credit cards or paper dollars, not as an alternative to USD. These people will not care that a new currency will be worth more in six months, most of them are not in the business of holding investments but the business of selling their wares. That’s why the number of transactions taking place in muni bonds or whatever is essentially nil.

Note also the tax consequences. Selling bitcoin is a taxable transaction, so even if the customer doesn’t report the gain, the business will probably have to (because it’s easy to audit their books). So they will take the capital gain on the appreciation of the currency, which at the very least alters the switching equation. But more likely you’ve just complicated it further for many merchants, who again are not in the business of holding. We’re also getting into derivatives and currency taxation, and since it’s clear that this is not hedging, these businesses are in danger of being taxed as investors – so their expenses, gains and losses will be capital and thus unavailable to offset the ordinary income of the actual business.

I think the taxes and switching costs, in addition to the network effects, make it unlikely that many businesses will be interested in freely switching to new cryptocurrencies.

NPW December 30, 2013 at 10:18 am

Bitcoin appears to me to be a middle-middle man in a transfer. If I want a flying monkey and Bob wants dollars for a flying monkey, both Bob and I will exchange dollars. Alternatively, if I want a flying monkey and Bob wants to dollars for a flying monkey, I can give him Bitcoins which he changes into dollars.

In the end, Bitcoin is like a check, cashiers check, or travellers check, not a currency.

We are just speculating on the value of a check, because we speculate on the most ridiculous things.

nl7 December 31, 2013 at 8:29 pm

Checks purport to be worth their face value in currency, so they don’t usually flow separately (at least as long as everybody expects the cashing to be certain and nearly costless). Might be better thought of as a commodity. An ounce of platinum only purports to be an ounce of platinum, and its price moves. Or maybe it’s just easier to think of it as a piece of paper like a stock or bond with a floating value. Except where platinum has some intrinsic physical good, which is expected to always retain some value, and where a share or a bond includes some right to the profits or corpus of a going concern, the piece of digital paper is by itself worthless. Which sounds basically like fiat currency.

Dan Weber December 31, 2013 at 11:34 am

The hurdle of “switching from not accepting bitcoin to accepting bitcoin” is vastly higher than the hurdle of “switching from accepting bitcoin to accepting both bitcoin and dogecoin.”

I.e., once you’ve done the work to accept one cryptocurrency, it’s really easy to accept the next.

nl7 December 31, 2013 at 8:22 pm

I’ll take your word for it that once a merchant knows how to quickly liquidate BTC for USD they also know how to liquidate any other given cryptocurrency (I’m guessing there are clearinghouses or banks of some sort?). But if the various currencies are differentiating based on their expected appreciation algorithms, that requires knowledge of the algorithm in advance. The alternative to knowing the algorithm and the expected rate of inflation or deflation is to calculate the NPV of the various digital currencies, assuming some reasonable rate. But once you use NPV, then all currencies are directly comparable, so $100 NPV of one is $100 NPV of another; so the only way for Tyler’s game to work is to find a mismatch or a rube.

Maybe the benefit is that one parties like to hold for X time and another party likes to hold for Y time, so a faster inflating currency makes sense for both than a slower one, right? Except that even in this case, if there’s an available fully functioning market, then arbitrage ought to pull all the cryptocurrency prices together, right? Nature abhors a vacuum and economics abhors price differentials. So the mismatch game shouldn’t work if there are enough investors, speculators, hedgers, and institutional wholesalers. The law of one price; the various cryptocurrencies should have spot prices that tell you their worth, same as bonds with different rates and maturities.

So the switching cost would normally be that a new user has to understand and anticipate the economics and inflation rate of a given currency. The best way around that is to reduce them all to prices that already reflect their expected returns (prices set by a vibrant trading market). But once a currency is reduced to a simple spot price, a price that integrates its expected inflation and future value, then the game Tyler is playing disappears. It’s all just different ways to count tokens exchangeable for dollars.

RichyB January 2, 2014 at 3:27 pm

I think when McDonalds and Burger King begin to accept Bitcoin as a form of exchange for their good(nes)s and s(weet)ervices, that’ll be the tipping point in favour of this legendary cryptocurrency… Go Bitcoin!

Nick January 11, 2014 at 1:25 am

Currently you can from your cell phone use bitcoin fairly easily with Its not perfectly ideal, after you have it figured out it takes less than 5 minutes, and you get a 3% premium based on what you spend, IE you turn $100 worth of bitcoins into Burgerking gift cards, you get $103 in Burger King dollars.

rr December 30, 2013 at 10:14 am

Not sure i get some of the comments; why would a largely freely convertible crypto-currency display network effects? And are switching costs between competing crypto-currencies really high?

(Also, if TC is on the right track here, what does the price of Bitcoin tell us about the “marketing” power of the Silicon Valley machine…? VC investors are really betting that there is no other non-governmental entity that can match SV on these terms)

Ryan December 30, 2013 at 10:45 am

Costs are high if there is no liquidity!

nl7 December 31, 2013 at 8:35 pm

Network effects: Try buying a pizza with dollars. Now try buying a pizza with pesos. Then try with Bitcoin. Then try with a new cryptcurrency you made up yesterday. For bonus points, try paying for pizza with a corporate bond or a bit of precious metal.

If nobody acknowledges that your fiat currency has value, or nobody acknowledges that they want the value for their goods, then there’s little point to using it.

Mike Johnson December 30, 2013 at 10:16 am

Excellent article. Too bad the title isn’t “How I have completely failed to comprehend Bitcoin.”

May I suggest some reading materials? Start here.

Andrew Moroz December 30, 2013 at 10:18 am

Seems to me the premise is wrong: Bitcoin is not easily replaceable with a copycat. Aside from the obvious network effect of its larger base, security and irreversibility of transactions increases as users increase (more precisely, as miners increase). As more time passes, competing currencies fall further behind and become less of a plausible alternative.

The most obvious way a competing currency could overtake Bitcoin is to add a feature the current algorithm doesn’t have but the market demands. For example, it was clear that the Bitcoin hashing scheme being susceptible to custom ASICs would lead to a professionalization of mining operations. One negative possible result is the concentration of power of determining which transactions are allowed in the blockchain and which are not. Some large mining pools have allegedly been biasing against gambling operations, for example. Litecoin has a hashing scheme less susceptible to professionalization, at least at this point.

But anyway, the point remains that cryptocurrencies are not interchangeable. There’s a very strong winner-take-all effect that extends beyond the eBay-type network effect.

For anyone interested, I wrote up a little semi-technical guide to Bitcoin some months ago:

Philip Crawford December 30, 2013 at 5:13 pm

Andrew, that’s an excellent guide.

NK December 30, 2013 at 9:54 pm

You are wrong, but it’ll take time for that to become obvious.
Bitcoin is extremely easy to replace just like millions wrent to CentOS from RedHat.

bighak December 30, 2013 at 10:25 am

You say:
>you want some Bitcoin, let’s say to buy some drugs

Then you say:
>And you find someone willing to sell you Bitcoin for about $500. But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400.

Wait you were buying btc to buy drugs because there are people willing to sell drugs for BTC. Are there people willing to sell drugs from QuitCoin? QuitCoin’s value is a not a number they determine, it’s value come from it’s usefulness as a medium of exchange. Small network = Small value to the holder. Jump starting a new altcoin is very hard. It’s a lot like trying to build a new ebay.

ladderff December 30, 2013 at 11:38 am

QuitCoin’s value is a not a number they determine, it’s value come from it’s usefulness as a medium of exchange

I believe this is the key error in thinking about bitcoin. It is not usefulness as a medium of exchange that matters. Let’s think for a minute of cash and bank deposits as two different “currencies” and then note that people rarely hold large volumes of the former (bills stuffed in the mattress) and routinely hold large amounts of the latter. This is true even though the exchange value of a number written down in your bank book is zero—you have to visit an ATM first and get the green pieces of paper in order to spend them. (Someone is going to point out that there are debit cards and credit cards and etc. Pretend there aren’t.) You don’t hold piles of green paper, even though they have the widest acceptance as a medium of exchange, because green paper isnt’ a good store of value (no interest, chance of disaster or theft loss, etc).

Store of value trumps medium of exchange. Tyler clearly doesn’t get this.

Bill December 30, 2013 at 10:26 am

I have been trying to figure out how to short bitcoin. Any ideas?

Jake December 30, 2013 at 11:08 am

Do a google search. There are plenty of ways to short bitcoin with options.

Yancey Ward December 30, 2013 at 11:22 am

Try offering a written option contract to a wealthy Bitcoin enthusiast that states something to the effect – “On January 1st 2017, I will pay you ten Bitcoins if you give me $5000 today.” Surely you will find someone to take the bet if you offer it widely enough, though you may have to put up some collateral to do so.

nl7 December 31, 2013 at 8:43 pm

This would’ve been my answer. You don’t need a broker to short something, you just need a binding contract (specifically, selling a call), two corresponding transfers (or a netting provision), and a precise date and time. Of course, you might find it easier to find buyers if you’re willing to hold the bulk or entirety of the contract amount in escrow until the settlement date, or to let the other party simply hold it all and then the ‘loser’ pays the net amount in cash to the winner. Which is financially indistinguishable from a bet.

Tyler Cowen December 30, 2013 at 10:30 am

A lot of people here can’t understand that network effects are already being discussed under a broader heading in my post.

Ryan December 30, 2013 at 10:55 am

Would you please put a time limit on your prediction?

Jake December 30, 2013 at 11:24 am

Enough with these inane bitcoin posts. I would bet you haven’t even ever used bitcoin, so quit talking about it in theory. Go use it, trade it on exchanges, and buy goods with it before you criticize it because right now you don’t seem to even understand it well enough to pretend that you know what you are talking about.

Here is a place you can buy some:

Here is a place where you can download a wallet for your computer:

Here is a list of places that accept bitcoin as payment for goods and services:

The reality is that bitcoin’s price took a tumble when China effectively outlawed CNY–>BTC & BTC–>CNY transactions. Makes sense since China accounted for about 47% of bitcoin transaction volume. The price may tumble temporarily a bit more when the Chinese finish cashing out before the Chinese New Year (the deadline given by the PBOC), but it will recover as more people around the world adopt it.

The main thing holding bitcoin back right now is not regulation or potential competitors or even its volatility. It is that it is still too difficult to use for someone who is not at least a little bit tech savvy. This will change as time goes on since it is only a matter of time until someone develops a killer smartphone app for bitcoin that makes it easy to use and safe from hackers.

Philip Crawford December 30, 2013 at 5:18 pm

I don’t think TC was criticizing bitcoin. He’s merely (as an economist should) talking through economic theories related to cryptocurrencies.

I’ve reread the post and still don’t see any criticism of bitcoin.

Mike Linksvayer December 30, 2013 at 12:11 pm

Broader heading is “marketing costs”, right? Sounds right to me. Some organizations might have very low marketing costs — mandatory payees, i.e., governments.

Mondfledermaus December 30, 2013 at 11:09 pm

Tyler just call Bitcoins for what they are… digital tulip bulbs.

Stephen Gornick December 30, 2013 at 10:44 am

Silver is roughly similar to gold, if you are talking commodities which can be used as money.
PayPal is roughly similar to writing a check, if you are talking payment methods for reimbursing someone who had paid for your lunch.
Dogecoin is not a substitute for Bitcoin. Not by a huge margin.

The difference is one that you aren’t appreciating because we haven’t had any malicious actors prove to you how unsafe proof-of-work based altcoins are. Do not be lulled into a false sense of security. There may be a 51% attack occurring on an alt-coin at this very moment. But you wouldn’t know it because the evidence of an attack occurs only after the damage has already been done. So let’s say an hour from now you go to withdraw your Dogecoins (or other proof-of-work based alt) from Cryptsy exchange (or some other alt-coin exchange) but the exchange can’t honor your request. That would be because the attacker had double-spent against the exchange and the exchange is now bankrupt and has frozen all accounts. Not only that, if you never even touched Dogecoins but just happened to store your bitcoins at Cryptsy those too might now be gone (as all creditors to a bankrupt exchange are treated equal — whether you had deposited Dogecoins or bitcoins or were owed for server hosting even, for instance.)

So, … please appreciate that the difference between Dogecoin and Bitcoin isn’t just that Bitcoin was first, or Bitcoin has the network effect, blah blah blah. The difference is that Dogecoin has extreme exposure to the risk of total catastrophic financial loss due to a malicious 51% attack performed for the purpose of committing fraud (theft). Bitcoin too has the risk of a 51% attack. But Bitcoin has 9695.76 Ph/s of mining capacity protecting it and Dogecoin has maybe three or four orders of magnitude fewer h/s (even after adjusting for the difference between SHA h/s and a Scrypt h/s).

Think of the difference between the two being like this Dogecoin is among the bottom of junk bonds and Bitcoin is a 1-month T-Bill. Except they both offer the same yield (which is zero). Which of the two would you hold?

john personna December 30, 2013 at 11:43 am

It is interesting that you close with the t-bill, because it is the “cleanest of dirty shirts” argument that has supported its value and low yield. With regard to fears of “attack” you are saying Bitcoin is the cleanest shirt. But in terms of safety, certainly the t-bill still is.

Which brings me then to what I was thinking as I read your comment. Yes we have these things, gold, t-bills, PayPal, and BitCoin.

Who chooses BitCoin and why? Are there actually pragmatic advantages for daily commerce? Should my mom use BitCoin over PayPal?

Yancey Ward December 30, 2013 at 12:19 pm

What did your Mom do before Paypal?

john personna December 30, 2013 at 12:46 pm

Is that an interesting answer(ing question)?

Technically, my mom doesn’t use PayPal and shops the old fashioned way. Were she more net-savvy she could move to PayPal for very wide internet storefront acceptance. If she were to go further, to BitCoin, why? To be a cool kid? Or, as I ask, is there an easily defined consumer benefit over PayPal?

Yancey Ward December 30, 2013 at 12:54 pm

My point is that people had the same questions about Paypal, and probably answered them through experience. Why not just Google the uses of Bitcoin and judge for yourself?

john personna December 30, 2013 at 3:39 pm

Riiigh, but as I say, PayPal satisfied (that is, already satisfied) a known need. I’m asking for the new need to be satisfied.

Yancey Ward December 30, 2013 at 4:35 pm

One need it satisfies is the ability to electronically transfer funds between two people without a bank/credit interface.

john personna December 30, 2013 at 5:15 pm

Um, if you mine all your coins, perhaps. Otherwise you probably bought them with a credit card. But going with what you say, perhaps it is a feature that you can mine currency and then buy things. I’d say that is a limited “market,” as in fact most people do have money and faster ways to earn it.

What is the current ROI on a mining rig? That might be interesting to hear in this conversation. If I drop say $5K (is that the right amount) to mine furiously, how long does it take me to make $5K in Bitcoin?

john personna December 30, 2013 at 5:20 pm

To answer my own question, says that you can spend $2500 on a rig and go into the black in 168 days.

Yancey Ward December 30, 2013 at 5:58 pm

No, John, it is perfectly possible to buy Bitcoins without a credit card or any other electronic transfer of dollars. However, the bigger point is that you don’t have to buy your Bitcoins every single time you make an electronic peer-to-peer payment. And even better, one can do it using pseudonyms.

john personna December 30, 2013 at 6:17 pm

You don’t mean buy them (“without a credit card or any other electronic transfer of dollars”) you mean barter or trade for them.

“And even better, one can do it using pseudonyms.” Semi, until the FBI runs the back-trace. As we’ve learned the nature of BitCoin includes a permanent record of all past transactions, and one that can be tied to individuals who are not absolutely rigorous about their online anonymity.

But is that your “value” over PayPal then? Becaz hatz government? Or to do crime?

john personna December 30, 2013 at 12:47 pm

(To be in on the bubble, or becaz hatz government, are both bad answers.)

HennessyHemp December 30, 2013 at 8:31 pm

That calculator can be inaccurate as you need to account for the loss of time between now and the time you get your mining rig. In between now and then several things can and will happen. The price of Bitcoin may fluctuate, changing the ROI either for or against you. The device you purchase, depending on what kind of coin you’re mining (in this example, Bitcoin…so we’re talking about ordering ASIC technology which is notoriously late on arrival times) may or may not be delivered in a timely manner (there are very few mining rigs you really want to buy that are ready to ship right now, most are pre-ordered like you wouldn’t believe…devices have yet to be made at the plant and they are two-four ordering cycles ahead bought and paid for, waiting for production and shipping, and your name is not likely on their list).

Considering that two to four generations of miners are bought and paid for, we can reasonably assume the “Difficulty” factor will be raised exponentially to account for the increased network hashing power, which may go up 2-4 times or greater based on the new units becoming in use ahead of you, making the value of your unit exponentially less as your mining power will be depreciated by the time it is delivered. Make sure you over-estimate the hashing power of the network significantly…the manufacturers are not likely to create gold minting machines without making a few units for themselves well ahead of the units which are shipped from their production lines. Remember the adage, the real millionaires of the gold rush often sold shovels.

john personna December 31, 2013 at 11:45 am

Concur. I suppose though for a certain affluent segment a “rig” would have made a good Christmas present!

Stephen Gornick December 30, 2013 at 12:54 pm

Ya, maybe a t-bill was a bad example. But yes — Bitcoin is vulnerable to a 51% attack as well. Such an event occurred in 2013 even — in March when a bug in the pre-v0.8 clients was discovered that caused a hard-fork. During that hard fork someone took the opportunity to use that hard fork to successfully double-spend against an exchange (OKPay) for a not-very-small amount (value ~$10,000).

So yes, Bitcoin and other proof-of-work based crypto coins all have a risk that other forms of money do not — the 51% attack. The degree of risk varies inversely proportional to the level (and distribution) of hashing capacity performed by the coin’s miners.

Zooko Wilcox-O'Hearn December 30, 2013 at 10:53 am

If this argument were correct, and the participants in the market were aware of this argument and persuaded of its correctness, then this step would not hold: “they have built deflationary pressures into the algorithm, so you expect QuitCoin to rise in value over time”. Therefore, this argument would not be correct.

Tal December 30, 2013 at 10:12 pm

Correct. Tyler seems to be stating a disbelief in the EMH. It is impossible for the value of the new currency to be widely expected to rise. Any future beliefs about a price rise would be reflected in the current price. So the only benefit of the new currency for a normal user goes away, and it can’t gain a foothold.

Brian December 30, 2013 at 11:07 am

But what’s bad for the price might be good for the currency.

It seems as if one of the things holding cryptocurrency back from realizing its dream of acting like an ordinary currency is it’s price volatility. If the price of Bitcoin were to collapse to a stable level which is anchored to a real economic cost, it would function much better as a medium of exchange even as it functions less well as a speculative investment. No?

dwayne stephenson December 30, 2013 at 11:18 am

So now I’m being told that I should trust in Bitcoin because it has some really awesome anti-piracy software. But look-before Bitcoin existed, no one had this kind of problem.

All this talk of “networking effects” is kind of a yawner. Not everything is like facebook. There are already well established currencies (the dollar, for instance, which Bitcoin remains subservient to). For Bitcoin to function as a currency, rather than a shibboleth for tech-pretentious libertarians, it necessarily has to make more space in the realm of options for currencies than presently exists. And if Bitcoin can do it, there’s no reason to think that can’t be replicated by other cryptocurrencies. And I’d be a little concerned about any technology that depends on Moore’s Law. It’s like basing a currency on the idea that man can never travel faster than 15 miles an hour.

Over and above that, what Jon Teets said. Imagine a world where the government can monitor every transaction because transaction monitoring is a part of the system that ensures the authenticity of the currency. Even if the adopted currency is Bitcoin, seems like a pretty steep price in exchange for the horrors of two to four percent inflation.

Yancey Ward December 30, 2013 at 11:27 am

I get the sense there is a great deal of beg the question fallacy to Cowen’s argument.

ladderff December 30, 2013 at 11:56 am

The first thing one must do before making claims about bitcoin is see if the claims make sense after s/bitcoin/gold/ or s/bitcoin/dollar/.

This is easy to do with Tyler Cowen’s post for example:

Back in the bad old days of metal money, someone or other could have decided to offer the world stamped iron coins. Indeed this was tried in various places and times, but it never had more than local (temporal and geographical) success. It did not actually threaten gold and/or silver as the real store of value. Also, the hippies of Ithaca, NY have been putting their own “currency” into circulation for over twenty years. Nobody says this will topple the dollar, and nobody with a brain would actually store wealth in the form of Ithaca Hours. As I remarked earlier this morning, store-of-value trumps medium-of-exchange.

Money is a coordination problem. People will choose bitcoin over zitcoin because people are choosing bitcoin over zitcoin—kind of like how all the kids in school in the early 90s bought pogs and nobody wanted any of the knock-offs that arose.

Some day either dollars or bitcoin will be worthless. The question is which. When you take the natural threat bitcoin poses to existing issuers (ie, Washington, Frankfurt) and put Tyler Cowen in those government’s ears making bitcoin sound like some kind of scam, the odds may well be against bitcoin—but not for anything like the reasons given in the OP.

Locke December 30, 2013 at 1:22 pm


john personna December 30, 2013 at 5:26 pm

Not to be course, but s/bitcoin/tulip/g

I mean, that does sound like a cheap shot, but everyone getting into mining is a little like everyone getting into planting. Now sure, the thing we are told is that the increasing computational complexity makes mining harder with time, preventing a tulip-like surplus. But if that is the case, a lot depends on the algorithm for “harder” being “just right.” Not too weak and not too strong. Too weak and everybody has too many Bitcoins. Too hard and people stop buying rigs, reinforcing a fall in computational power applied.

Nick December 30, 2013 at 11:56 am

It’s a fundamental problem that you can only get monopolistic rents if you can both 1) enforce a limited supply/prevent cheating and 2) prevent new entrants. Bitcoin algorithmically does the first, but unlike a taxing sovereign, can’t do the second.

It reminds me of an old b-school case study of real estate agents. They were able to effectively enforce a high commission (say, 7%) by restricting access to the multiple listing service to only those agents who were willing to set the enforced commission. But because these commissions were so high, it attracted a lot of new people to become agents, such that everyone was getting less business than before. So even though they got 7% per sale, each individual agent got fewer sales (because there were so many agents), and the average agent’s income was about where it would have been without the collusion.

In the same way, bitcoin can restrict the number of total bitcoins, but it can’t restrict the total number of “e-currency that can’t be used to pay taxes in the US”. So as long as you can exchange bitcoin for litecoin or whatever else comes out next, there is no effective limit on the number of equal substitutes for bitcoins, and therefore it is as susceptible to inflation as much as any other currency.

Ryan December 30, 2013 at 12:14 pm

The main reason I am bullish on bitcoin is the astounding number of smart people making astoundingly bad arguments against it.

RPLong December 30, 2013 at 12:18 pm

Another great point.

Zooko Wilcox-O'Hearn December 30, 2013 at 12:47 pm

Ryan: well put!

Andrew Moroz December 30, 2013 at 1:22 pm

Completely agreed.

NK December 30, 2013 at 10:04 pm

So the worse something is, the more likely you are to be optimistic about it.
Nice strategy.

Philip Crawford December 31, 2013 at 9:47 am

What does it mean to be “bullish on bitcoin”? Does that mean you are bullish on the price of a bitcoin? Or bullish in terms of bitcoin’s importance in future commerce? Or both?

Seems like many people assume that anyone who thinks the price is overly inflated also think that person is “against” bitcoin. I don’t understand that seemingly simple view of the world.

David December 30, 2013 at 12:35 pm

Does the Bitcoin brand and the thickness of its market count for anything over the long run? I suspect the answer is yes.

Back in business school we did a case on eBay where the professors argued that the success of eBay wasn’t due to the thickness of the market, because of the law of one price.

I never liked that argument, because thicker markets usually yield better matches. I also thought it was a mistake to ignore the importance of the eBay brand.

Bitcoin has a thicker market than its competitors and a strong brand. Maybe that makes it the eBay of cryptocurrencies.

Matt Young December 30, 2013 at 12:36 pm

Tyler’s theory will not hold if we believe in Patterns of sustainabiloity and specialization. The new theory predicts a balance between sustainability and specialization, which Kling should soon discover. The cryptos will specialize a bit, some backed by retail chains like they do store coupons, with trademark branding.

My PSST theory One: Something with very low marginal costs becomes a component in some specialized version of that product. Kling owes me a banana.

ugh December 30, 2013 at 12:53 pm

This post is retarded. Do some actual research rather than just speculating and spouting “theory”.

Ray Lopez December 30, 2013 at 12:53 pm

BITCOIN BITCOIN BITCOIN! THE NEW HEALTHCARE MR OBSESSION! LONG LIVE BITCOIN! now i will read all 177 comments and comment on each and every one…

Jon December 30, 2013 at 1:12 pm

The real reason bitcoin will drop is because its a pyramid scheme. The innovation of bitcoin is that it’s a OPEN-SOURCE pyramid scheme, allowing currently 60 others to copy the pyramid scheme, based on By making the pyramid OPEN-SOURCE, many are much more drawn to promote the pyramid scheme as opposed to a closed-source pyramid scheme.
The algorithmic nature of this pyramid scheme and the public ledger also makes the pyramid much more transparent. I believe these are the reasons bitcoin became so popular. Bitcoin certainly has first mover advantage. I dont think the logic behind this article is sound. To access the other 60 pyramid schemes, you need to buy BTC. Ergo, Bitcoin now also provides the function to participate in many more pyramid schemes, not just itself. I wonder if the early adopters were so prescient.

Sage December 30, 2013 at 1:25 pm

Ummmm, I think you’ve been dabbling a bit too much into the crypto punch. TROLL

tom December 30, 2013 at 1:31 pm

“But then the QuitCoin company comes along, with its algorithm, offering to sell you QuitCoin for $400. Will you ever accept such an offer? Well, QuitCoin is “cheaper,” but of course it may buy you less on the other side of the transaction as well. The QuitCoin merchants realize this, and so they have built deflationary pressures into the algorithm, so you expect QuitCoin to rise in value over time, enough to make you want to hold it. – See more at:

This is wrong- bitcoin doesn’t have deflationary pressures built into its algorithm, it has inflationary pressures built in. The reseason the price has risen over its life time is that a market has sprung up for its use, and the demand has outstripped the increasing supply. Your new “it-coin” has to convince the buyer not only of its algorithmic soundness but also market adoption.

Fundamentally bitcoin was heavily “inflationary” in its early days, and this helped build the base that now makes it look “deflationary”.

Steve J December 30, 2013 at 4:45 pm

“This is wrong- bitcoin doesn’t have deflationary pressures built into its algorithm”

Aren’t there a limited number of bitcoins? How could that not be deflationary?

bighak December 30, 2013 at 7:11 pm

There is about 11M bitcoins right now. There is creation of new bitcoins to reward miners until around 2140. If market demand for bitcoin is less than the newly mined bitcoins arriving there is inflation!

Patrick December 30, 2013 at 1:37 pm

Apparently Tyler Cowen has never heard of the network effect.

August December 30, 2013 at 1:46 pm

If it is a pyramid scheme, it is the only pyramid scheme in the world where you could take out the top, and it would still keep going. I am sure there are a lot of people trying to manipulate the price, but the underlying issue here is we are seeing a technology designed to subvert the governments’ holds on currency. It might be to bitcoin’s benefit to be banned. If people find themselves capable of transacting with it anyway, despite the bans, the value will go up. Some folks suffer from a lack of imagination- initially a ban will cause some panic, but then you’ve got a lot of people with some of them just sitting around, and a lot of them would likely be impounded, resulting in fewer of them.
What will those people with a lot of them do? They’ll keep an eye out for a way to get value out of them. They will innovate new ways of doing things- even if it is printing them out on little pieces of paper. I don’t know that this is a for sure deal. Possibly the network is still small enough for governments to collaborate and root it out, but everything that has happened so far is consistent with what Satoshi Nakamoto said.

jon December 30, 2013 at 5:13 pm

It IS a pyramid scheme. The only way youre gonna make money with Bitcoin and other cryptocoin if greater fools buy it from you for a higher price. That guy also wants to get price appreciation. So you get a chain of fools who expect to sell at higher and higher and higher prices. The guys who bought bitcoin at $1200 expect to sell at $2000+.. etc. The guy who buys for $2000 sells for $3000… get it? There is no question about it thats it’s a pyramid scheme. Even when bitcoin doesnt appreciate in price at all, to get in you have to pay the early miners. Those early miners spend alot less electricity than the ones who came later. Basically people have to agree to transfer wealth in to the hands of higher levels in the pyramid, to ever make use of bitcoin.
But it differs, I agree from, traditional pyramids: open-source, algorithmic, slow, no fixed downline and upline, as you said. Even promoting it is easier.

Lasse Birk Olesen January 5, 2014 at 2:14 am

So gold is also a pyramid scheme?

Adam Apple December 30, 2013 at 1:46 pm

This really odd. We have people that obivously don’t know that much about cryptocurrencies commenting on the price of bitcoin and then a large audience (many of who don’t know much about cryptocurrencies) posting, saying whether the prediction is wrong or right.

Why don’t both the readers and writer of this article actually learn a lot more about cryptocurrency before commenting on it?

As someone who actually knows a lot about the subject, many the postulations of this article are wrong and foolish, and many of the comments are way off. I find it unsettling how certain some of you are in your ideas, yet, without having spent actual time studying the subject.

I would not go on to a physics article and make all these absurd comments about the latest Higgs Boson findings unless , like, I least had some idea of what it was I was talking about… I wish more people would feel the same way.

*** short version: Readers: you should learn from EXPERTS, not from people with a rudimentary understanding of the subject. What a waste of time.

Ray Lopez December 30, 2013 at 2:29 pm

Specifically, what do you find way off? Likely you are off, or talking your book. I find TC pretty much made a good case from an academic point of view of why bitcoin is inevitably doomed to fail, but, if you read my comment, you’ll see that “inevitably” can be a long time. The tau, or “time constant” to use an electrical engineering term of art, is what is at issue here. How soon will bitcoin fail? Sooner or later? That’s the question.

Steve J December 30, 2013 at 4:55 pm

Possibly you could explain why cryptocurrencies are so different? If you can’t explain it in a few paragraphs then I think we have to fall back on don’t buy a financial instrument you do not understand. Tyler’s argument seems to make sense to the non-experts.

Bill Reeves December 30, 2013 at 1:47 pm

What lessons do the early days of American banking have? Back when there was no paper currency and individual banks would issue their own banknotes redeemable in gold or silver (theoretically). Were those competing fiat currencies or was the promise of redemption in specie credible?

Ray Lopez December 30, 2013 at 1:55 pm

All this talk about bitcoin theory reminds me of the joke about three shipwrecked and starving castaways: an engineer, a chemist and an economist trying to open a can of corn on a desert island. The engineer proposed bashing the tin on a rock and extracting the contents that way,but the chemist and economist objected since it was unsanitary. The chemist proposed heating the can in the sun until it exploded, but the engineer and economist objected due to the waste that would ensue from flying corn kernels. Finally the economist thought of a brilliant way of opening the can: he immediately started scribbling complicated equations in the sand. Fascinated, the engineer and chemist waited in eager anticipation of the solution, with a new found respect for the economist. After the economist filled the beach with equations, and several hours later, he finally held up an index finger to call attention to his proposed solution. With baited breath the other two waited while the economist cleared his throat and thus spake: “Let us assume a can opener…”

Steve December 30, 2013 at 2:21 pm

Did I miss something, or did TC’s analysis apply to any new currencies, not just crypto-currencies or even digital currencies?

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