How and why Bitcoin will plummet in price

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.


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?

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?

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.

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.

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.

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.

"“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.

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.

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...


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.

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.


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

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

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

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.

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).

>>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).

That answer is basic......cost.

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?

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.

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.

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

Thus Bitcoin acts as a cool-kids PayPal.

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

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.

My thoughts exactly.

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

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.

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.

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

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

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 -

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.

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.

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...

Sorry, "more deflationary" rather than "more inflationary".

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.

I would tend to agree with this assessment.

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.)

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.)

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!

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.

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.

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.

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.

Coinbase account for a MOOC ? How so, sir ?

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.

Bitcoin decimal places are already extensible.

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?

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.

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.

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

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.

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.

Is that what Canada's effort is likely about?

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.

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.

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.

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.

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,


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.

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

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.

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.

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?

@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.

"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...

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).

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.

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

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

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

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

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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?

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.

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.

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.

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.

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.

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!

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.

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)

Costs are high if there is no liquidity!

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.

Excellent article. Too bad the title isn't "How I have completely failed to comprehend Bitcoin."

May I suggest some reading materials? Start here.

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:

Andrew, that's an excellent guide.

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.

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.

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.

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

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

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.

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.

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

Would you please put a time limit on your prediction?

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.

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.

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

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

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?

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?

What did your Mom do before Paypal?

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?

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?

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

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

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?

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

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.

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?

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

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, 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.

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

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.

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.

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.

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?

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.

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

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.


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.

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.

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

Another great point.

Ryan: well put!

Completely agreed.

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

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.

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.

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.

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

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...

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.

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

"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".

"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?

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!

Apparently Tyler Cowen has never heard of the network effect.

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.

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.

So gold is also a pyramid scheme?

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.

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.

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.

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?

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..."

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

I don't really understand the point here. If you want to buy $400 worth of drugs, it doesn't matter whether you do it through bitcoin or some altcoin. So you'll use whichever one is easiest. The price of one unit of the altcoin is completely inconsequential unless you plan on holding it for longer than it takes to buy your drugs. It's still $400 of drugs whether you pay .8 bitcoin for it or 1.2 altcoins.

I re-read the second paragraph and I guess it is talking about holding the altcoin for some amount of time in hopes that it will rise in value. In which case I don't think I disagree with anything except for the estimate of how much "marketing costs" will be. The entire value of the coin is in the number of people using/trusting it. It's very difficult to just buy that, so I expect one winning deflationary coin and the rest to mostly fail.

Hi Tyler,

You write, “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,” and the link for the work “optimistic” is to a photo of me.

I don’t think I’ve ever said anything to suggest that I am optimistic about Bitcoin’s price. Indeed, I have always argued that Bitcoin’s price is not worth all the attention it gets. To me what matters is the technological genie that Bitcoin has let out of the bottle. I put it this way in April of 2011:

Do I think Bitcoin will replace the dollar? No. Might Bitcoin have certain systemic design flaws that might impede its success? Quite possibly. Will Bitcoin become the de facto, manipulation-proof currency of the internet? Who knows. […]

That all said, what I do think is revolutionary about Bitcoin is that its developers have solved, without the use of a middleman, the double-spending problem faced by virtual currencies. That gives us license to realistically imagine a world without regulable financial intermediaries online.

My interest in Bitcoin is not monetary, but instead about what the technology means for the regulatory levers available to governments. I understand those two things can’t be entirely separated, but for now the proof is in the pudding. People are indeed buying and selling goods and services online despite governments’ wishes.

Bitcoin’s first-mover status grants it some advantage over its competitors in the form of network effects, but you are right that there is no reason why competition from other cryptocurrencies couldn’t drive down the price of Bitcoin. Since I’m not an economist, I won’t speculate on such questions and I’ll leave that to my colleague Eli Dourado, who I suspect will take issue with the “companies” you posit as issuers of competing currencies. As a lawyer I can tell you it would be very difficult for a company to markets its currency as good for drug purchases, as you seem to posit.

One final thing I’d like to note is that payments that are immune to prior restraint (what I call censorship-resistant payments) are not the only thing Bitcoin’s decentralized technology allows. As I wrote in a recent Reason cover story, Bitcoin is more than money. It has the potential to also be a decentralized predictions market, make possible decentralized assurance contracts a la Kickstarter, and much more. Each of these as-yet-untapped parts of the Bitcoin technology could pose interesting challenges for regulators, and that’s what interests me so much about the technology.

My enthusiasm for the technological breakthrough Bitcoin ushered in may indeed be mood affiliation, but I just wanted to make clear what it is I’m actually excited about.

Happy new year!

How does the promoter of a cryptocurrency collect rents? The only way he can is to monopolistically mine the first blocks (say, by doing so before releasing the source code). Now, it's telling that the second largest system by market cap is Litecoin, which released its source before mining the first block, so there's nobody collecting a rent there on my analysis.

The marginal cost of producing coins is a function of their demand, as the hash rate difficulty moves with the fx rate. Holding technology and the price of electricity constant, any increase in the $price of coin makes mining profitable, which attracts more miners (no barriers to entry), which raises hash difficulty after 2016 blocks,  which makes mining rewards equal mining costs again. It's as if the that seigniorage gets lost to entropy. That's why I think your analysis doesn't get us the economic insight we're looking for here.

Now, we need a theory to explain why a currency holder should (and, empirically,  for the most part does) eschew those altcoins with seigniorage baked into the blockchain upon launch and ignore the marketing dollars financed thereby. But let's say we've done that, what's left?

Well, we've got an answer to that competitive inside money literature: crypto money stops the race to debase because there's no rent for a 'promoter' to collect and the marginal cost of production equals the exchange value at any given point in time. Maybe those meaningless hash computations aren't socially useless after all.

But you're probably right about the valuation of Bitcoin. The cap on supply and the expected price appreciation has reflexive consequences similar to your story: speculative money demand kills tx money demand, making the whole thing like a liquidity trap based in greed rather than fear. We need a crypto currency with a money growth algo elastic enough to stabilise its fx rate. Technically possible. MonetaristCoin, anyone?

Now you're talking! But of course that will upset all the store-of-value fanatics who like baked-in deflation.

Hello, Tyler. I am just an uneducated dolt. I don't understand most of the fine points of Bitcoin debates . But it seems to me that most of the time majority of economists are wrong on anything non-trivial. I am willing to bet on this belief. Tyler, would you be willing to put a date and numerical value on your prediction of Bitcoin doom? How about this: we bet 200 by that date. If you win, I give you $200, if I win, you give me 200 bitcoins. As you see, if your beliefs are true, the rules are very heavily skewed toward you. What's a little bet for a guy like you?

Economists need to roll up their sleeves and do some clean new, 21st-century work on currencies. I think George Selgin has made a great start:

(I posted this on yesterday's post too.) I'm getting the sense that a lot of economists aren't able to evaluate Bitcoin in a useful way. Go see how lost Krugman is -- he's calling it evil, yes evil, because it damages "states ability to collect tax and monitor their citizens financial transactions." (he quoted Charlie Stross there) Wow, so that's where we are now -- it's okay to say, in polite company, that the state should be monitoring everyone's financial transactions...

The situation has all the makings of your standard paradigm shift, where pundits with less neurological plasticity give future history books lots of look-how-wrong-they-were quotes. I'm not saying that TC isn't a heavyweight thinker -- I just don't see much work being done here. Bitcoin might be a bubble, but there's more there than is implied in this post. It's not like the new math of tech startups pre-2001, where profits just don't matter and it's about mindshare or some such. We can point to compelling reasons why Bitcoin has value, and I don't see how network effects are accounted for in the headline or any other part of the post.

PK quotes DeLong as saying this: "Underpinning the value of gold is that if all else fails you can use it to make pretty things."

That's just false, right? Or, there's never been a time in history where gold just lost its preciousness and people fell back on their inner Martha Stewart. Maybe I don't know what he means. "All else" has never failed, re: gold. As far as I understand, gold doesn't have a backing -- it IS the backing. It's as close to intrinsic value as we have in our world (even $1200 an ounce is quite precious.) I'm not very confident in the Austrian/ZeroHedge understanding of the universe, but I don't think it makes sense to talk about what underpins gold's value in the way we talk about what underpins a currency's value. Ecologically, gold's value just never comes into question -- it's never been remotely worthless. It might all be based on weird human psychology, or perhaps every species in the galaxy has a thing for the shiny offspring of supernovae.

DeLong also says this: "Placing a ceiling on the value of gold is mining technology, and the prospect that if its price gets out of whack for long on the upside a great deal more of it will be created."

Is this right? Is this the principal factor in limiting upward movement in gold prices? It seems like spikes are driven by loss of confidence in central banks, inflation fears, etc. I suppose mining production helps contain the price, but I'm not sure there's a hard ceiling there. That's an extremely slow industry, and the gold price seems more limited by the fact that central bankers aren't completely irrational.

And "Placing a ceiling on the value of bitcoins is computer technology and the form of the hash function… until the limit of 21 million bitcoins is reached. Placing a floor on the value of bitcoins is… what, exactly?"

I think he has it flipped there. The cap puts more pressure on the floor than the ceiling. But nothing is guaranteed in life. These guys are almost Austrian in their demand for zero risk. We'll see how it goes, but if Bitcoin is evil, then I guess I should start shopping for a double-bladed lightsaber.

The gold analogy is a useful one I think. Mining costs do not have a material influence over the gold price in the short run because the stock of gold ever mined dwarfs the impact of one year's supply. Therefore, supply induced volatility is not a driver of gold price instability. From what I can gather (I'm by no means an expert) Bitcoin design mirrors this feature.

However, gold's position as a "store of value of last resort" in times of financial stress is grounded in thousands of years of history. In times of crisis people will tend to rely on the longevity of its role as a store of value precisely because it has stood the test of time - its "first mover advantage" over crypto currencies is unassailable in this way.

But gold is rarely used as a primary medium of exchange, precisely because its convertible rate relative to mainstream currency is so volatile. The distinction between buy and hold behaviour in Bitcoins vs short term transacting is overstated in my view, because the entire Bitcoin using community is essentially long Bitcoins - these must be reconverted to mainstream currency for most practical day to day transactions. Its very hard to effectively hedge Bitcoin vs hard currency and that inherent volatility is hard to manage. Of course this issue has generally not arisen to date as the price has typically appreciated, and as mentioned, users are long Bitcoins and therefore see this as a pleasing side benefit (which is classic bubble mentality).

So, I think Bitcoin is indeed gold-like in a bad way (poor medium of exchange) but inferior to gold in the good way (store of value of last resort).

I think for Bitcoin to sustainably succeed it needs broad community acceptance as being superior to government issued currency. I think the 99% of people not presently using Bitcoin will be difficult to convince of this.

This was already explained by Peter Schiff.

This articles makes no sense at all.

How exactly does QuitCoin get to be valued at $400? Where does the value come from? The company just decided that? What about market forces? Why would a cryptocurrency with no relative value to bitcoin be valued by the market at 80% of bitcoin? The best altcoin now trades at 1/30th the price of bitcoin, and none of the other altcoins come anywhere near that. How does QuitCoin get in the position of being .8 BTC in the first place?

How does QuitCoin manage to rise in value without the superior crypto currency bitcoin rising more? What market forces make that happen? Altcoins tend to trade at some narrow percentage of bitcoin, and the larger the value of the coin, the more stable the altcoin is and the more stable that range seems to be. How does this not happen to QuitCoin? If it were trading at .00001 BTC like 99% of the altcoins, then yes the swings can make it outperform BTC in some narrow time window, but there's a lot of RISK of the altcoin losing most of it's "value".

I think there's a fundamental misunderstanding that somehow there are companies behind these coins that can arbitrarily set valuations of a currency. Given that one of the big factors in determining the value of a cryptocurrency is that there is not company acting as a single point of failure, how do these companies create value in an altcoin that is missing one of the key values of a cryptocurrency?

I know this response has been more than a bit rambling, but I hope it's helped at least shine a light on a few of the areas where this analysis just makes no sense. I don't know the future of bitcoin, and I don't know if another currency will one day supplant bitcoin as the primary cryptocurrency. However, this article doesn't present any cogent scenario whereby that could occur.

There are two viable cryptocurrencies: Bitcoin and litecoin. The hundred or so monkey see monkey do cryptocurrencies are not being accepted as valuable, nor will the next zillion that are coming.

Someday an enterprising government will improve on Bitcoin and use the new eDollarCoin to track all transactions by all citizens (and non-citizen currency users). All government cash transfers in eDollarCoin. All taxes payable in eDollarCoin. Only eDollarCoin considered legal tender. The great dream will be realized.

The smallest unit of a bitcoin is not a whole bitcoin. It is one millionth of a bitcoin. Right now that still costs much less than a penny.

And bitCoin could be sub-divided further, if it became necessary.

There are many arguments against bitCoin. This one rests on an incorrect assumption of bitCoin indivisibility.

At an early stage in a peer to peer cryptocurrency's adoption, an adversary with computing power greater than that of all other users of the system can take over or at least confound the system by publishing alternate histories.

Arguably Bitcoin is over this hump.

But an entrenched monopoly or oligopoly of cryptocurrency miners can defend against new systems.

'cryptocurrency creators will, for reasons of profit maximization, *exempt themselves* from upfront mining costs'

Please explain this. I can't see how this would happen.

Surely the creators generate only sink costs up front, in creating the system. Creating the system creates no coin.
They only way they can recoup costs are after mining starts by:
mining coins (either cost of production < face value & sell OR hold and wait for increasing face value) or,
offering third party services (set up an exchange, consulting, going into hardware manufacturing etc)

The premise of the argument is that most people, when confronted with the opportunity to buy the established and majoritarian Bitcoin, versus some premined coin scam (engineered so the authors reap (raep?) future purchasers), will buy the scam instead of the real deal.


The author has assumed imbecility from everyone (but him, of course, since he thinks he's the shit and nobody ever had ever thought of his masta plan).

I cannot put into words how retarded the author is.

A few days ago, I wrote a post giving other reasons why it seems unlikely that Bitcoin will be the dominant cryptocurrency in the long run. May be of some interest:

I don't understand all of your argument (such as why the price of QuitCoin should have to rise after the initial exchange at $400), but I think I get enough of the gist.... Isn't the suggestion that bitcoin's price will be under pressure as cryptocurrency confidence increases about the same as the suggestion that gold's price should drop to the level of silver, copper or platinum as confidence in precious metals increases? That's not what we see, however. Currency's value isn't determined by cost of producing the currency. It's determined by trust that other people will honor the currency.

I wouldn't buy a euro instead of a yen because the dollar price is cheaper - I would buy a euro because I need a euro. The dude I buy my heroin from won't accept yen. Why does it matter what the dollar price is?

Like with other currencies you could maybe calculate an arbitrage value using interest rates and inflation. What is the interest rate for borrowing in bitcoin? Does anybody even do that? On inflation, I guess in the long run this is quite a deflationary currency so that would contribute to its value, but what is the long run deflation rate?

Professor Cowen, your anti-deflationary prejudices aside, when I read your blog post I cannot help but think you don't understand the workings of network effects. Perhaps these are much more obvious to computer scientists and engineers than economists, despite their consequences have important economic consequences.

It would not be particularly difficult for me to create a product that looked a lot like Facebook, and perhaps even have some features that Facebook does not have (which are easy to built at smaller scale), and I could call it TylerBook or FaceCowen. Now how many users do you think I would strip away from Facebook to this new product?

I would wager almost none. The network effect is part of the product itself. It is almost certainly the most important feature. This is why Windows remained dominant for so long despite being a crappier product than its competitors.

Money itself is a network effect. Bitcoin is orders of magnitude more liquid than its competitors and liquidity follows liquidity. Bitcoin's competitors could conceivably out-compete bitcoin, but they would have to overcome the overwhelming barrier of bitcoin's inherent network effect, which is much harder than you give it credit for. Litecoin's addition of scrypt, or PeerCoin's use of proof of stake are not big enough features to out-compete the difference in liquidity, which grows larger with time.

And of course, unlike most tenured economists, the market is telling us that bitcoin's deflationary design is preferred to some other non-deflationary scheme. So there's an obvious psychological reason why certain economists (yourself, Brad de Long, Krugman et al.) have a natural tendency to look at bitcoin with a jaundiced eye. It is because every success it has takes the anti-deflationary biases you have and tears them to shreds in the face of the public. Every time transaction volume goes up, despite the massively deflationary price tendencies of bitcoin, you all have more egg on your face. If I were in your position, I too would feel uncomfortable and would be arguing the whole system were going to collapse on itself. In fact I might start arguing it needs to be regulated, because how on earth could an unregulated currency actually work? And if I could advocate just enough regulation to kill it, then wouldn't I look really smart by predicting it would die?

Just a game plan for you.

About your "legit coin" comment, it has already occurred. J.P. Morgan recently filed a patent for a new money transfer mechanism that seems eerily similar to bitcoin. I agree that JPM's efforts are more likely to be successful than bitcoin.

See this article on the Economist.

That's nonsense (that JPM's effort are more likely to be successful), because Bitcoin is a DEcentralised distributed Coin (while centralized one-point-of-failure managed coins, are inferior to distributed P2P network coins). As long as so called "economists" have no profound knowledge about the Bitcoin-protocol, they should keep their mouth...

Tyler has no way of knowing whether the price of Bitcoin will rise or fall, because he doesn't know the value of cryptocurrency in general. That's to-be-determined by THE MARKET.

Bitcoin + alt-coins = true anonymity?

If you can wash your BTC through additional, independent transaction block chains, then perhaps true anonymity can be achieved.

So perhaps Bitcoin needs the alt-coins to become the truly liberating currency most adopters thought it originally had (but didn't).

First mover advantage? Does the author understand markets or economics at all?

Have you ever heard of Ebay? what about instagram? Twitter?

The company concepts are amazingly simple and easy to recreate. Why aren't any other online auction companies grabbing marketshare from ebay? there were 100s of clone sites after ebay started gaining traction...none were even moderately successful...

There are many competing paper currencies.
The creators of these get the seigniorage, so lots of motivation to do so.
Someone is optimistic about US dollars, and therefore about Zimbabwe dollars.
They will gradually become worth about the same amount.
A man needs dollars to rent whores.
The Zimbabwe dollar is much cheaper, so he gets those.

Similar points made here

Greater Adoption Should Mean Lower, Not Higher Prices

If, Bitcoin’s advantages lie in using a crypto currency system one would think that the cost of using it would decrease over time, not increase exponentially. The argument that more people will be using crypto currencies and more convenience and security features will be added to the Bitcoin system to justify higher Bitcoin prices runs counter to market principles. With competition, prices should drop.

The price of cars did not go up exponentially as more roads and bridges were built, motels and restaurants were added to the sides of the highways and more people used automobiles as a mode of transportation. Competition ensured that Fords would not be the only cars on the road and that prices for cars would remain affordable. Similarly, there will be additional competing crypto currencies, many superior to Bitcoin, that will keep a lid on the price of Bitcoin.

The peer to peer aspect of Bitcoin is superior to traditional electronic payment systems. Unfortunately, in order to access the system increasingly higher prices have to be paid to use it. This is a self defeating proposition. The Bitcoin system is substantially the same one of three months ago, but today Bitcoins cost four times more. Technology advances should make use cheaper not more expensive. To encourage adoption, prices need to be lower not higher. For example, Tesla will not increase the price of its cars ten fold as it adds more charging stations around the country to increase the utility of its battery powered vehicles. If it did they would see their sales plummet. If the price per Bitcoin remains high, competing lower priced crypto currencies will become more attractive and displace Bitcoin; especially since there are no barriers to entry in the crypto currency market.

The writer here sounds like a college student who just learned about Bitcoin. There are already other cryptos in the market accepted for various things. The market saturation for new cryptos will come at some point in the future but in the meantime those becoming the most established will eventually enjoy hegemony, regardless of minor improvements in new cryptos. Think Budweiser, not the best beer but does the job and has long established the largest network of distribution.

What's your theory of money? And value? Establish those first, clearly, then make your argument. Bitcoin will not fit into a standard theory of money in any way, and in fact it is a direct challenge to it, and we're all going to get to see if it works in practice. This is why BTC is not understood by most economists. A lot of economists talk about money, but I don't think they even have a clear definition for what it is.

In another theory, "money" is a good like any other, but with a very special utility set. For most goods, people seek the highest value at the lowest price. But when the utility of the good is actually its value, then you seek the strongest "value." Tyler, you're not trying to sell me a TV, you're trying to sell me a cryptocoin. Why would I spend one thing that is worth $500 on something worth $400? And how did QuitCoin get to $400 in the first place? And so what if you build in "delfationary pressures?" Is that a good thing, or a bad thing, long term? What if you built in "inflationary pressures?" I suppose if money is a tool for credit expansion, one might have a certain opinion about it. But what if money should just be a good, used to store and transact value? What if regular people, who have no clue about economic theories, just have utility for storing and transacting value, really quickly, and don't care to think about how governments finance themselves, since they are so ignorant as to believe that taxes account for all of that? What would money look like in a free market, if all it needed to be were money, and nothing else? If the "price" of money is what the market selects, as a composite view of many voluntary, non-coerced exchanges between individual buyers and sellers, then you use your weaker currencies to buy the stronger ones. Not the other way around. Once a currency becomes strong, it is hard to unseat it, and currencies become strong in free markets due to objective reasons for value. But we have to re-discover this.

There is no such thing as utility for another "equal" money at a lower price. It is a basic contradiction. The only way a lesser currency can attract buyers in a free market is with superior features. This, BTW, is why people are starting to select BTC over legacy money. Now realize that BTC is an opensource dev project, and it can be evolved and improved, and even augmented by other things like ZeroCoin.

Your argument for all crpytocurrencies trending to zero over time is a logical inversion. In fact, it applies perfectly to the dollar.

"New crytopcurrency called Coinye West to launch in January" -

"Tyler Cowen" piece is flawed in many ways. Two of them, I will try to debug below.

Two flaws are pregnant:
1) he mixes Centralized and Decentralized economics.
2) he doesn't reckon the differences between SHA256 and sCrypt networks.

The first point: he writes "But then the QuitCoin company comes along" and this one (central) company competes with a lower price, forcing Bitcoin (decentralized network) to lower its price. Well, this may work in a centralized economy, where the one supplier can set his price, but this isn't possible in a decentralized economy. First of all a Central-Coin cannot compete with a decentralized Coin (it misses essential features). And secondly, if QuitCoin would be a decentralized-coin then it cannot set its price (price is pure on Supply-of-many and Demand). Actually, to become a real competitor to Bitcoin, QuitCoin's supplier-profit (the miners in the decentralized network) should be much higher than Bitcoin's. The incentive for miners should be higher in order to persuade miners to switch from Bitcoin to another network. Which means an upward price pressure instead of a downward as Tyler Cowen argues.

The Second point: He doesn't understand what it takes to issue a new decentralized Coin. Sure, Bitcoin is open-source, can be copied very easily, and use top class marketing to promote it. But that will not make a new Coin, let alone be a serious competitor to Bitcoin. No! a decentralized coin needs an as large as possible P2P network of miners (the larger the more secure). This means that tens of thousands, geographically separated, individuals need to invest in costly equipment and electricity to connect to each other and mine the new coins. It took Bitcoin 5 years and more than $200.000.000 (in 2013 alone) to create the network of today. It should be clear that any new coin who wants to compete with (nearly) the same copy of open-source code has a nearly impossible task to gather enough miners for its new network: professional Miners will only join if incentives and success-rate are better than Bitcoin.
I see you thinking: but why do we have so many copycat-coins?
To answer this you need to separate the two encryption families: The SHA256, which needs extremely expensive ASIC-hardware. And sCrypt which can be mined by common PC's with a gaming-video-card. Bitcoin is member of the SHA256 family, and because of its hardware costs ($5000 to $13000 per Miner) is run by professionals. These professionals will not easily switch their expensive hardware to a new Coin. And this is why Bitcoin doesn't have any serious competition within the SHA256-family (PPC is a runner up, but I'm not aware of any shop that accepts them). And be aware: SHA256-hardware, physically cannot be used in sCrypt-networks, the opposite is possible but not profitable at all.
The major coin in the sCrypt-family is Litecoin. And yes, Litecoin is a competitor to Bitcoin (which is a good thing). Litecoin is a keeper, it was the first in the sCrypt-family and its network has grown in 2 years time to more than 40.000 Miners (a stable and secure network indeed).
In contrast to the SHA256, the sCrypt-family has many copycat-coins. But they all compete with Litecoin (not Bitcoin). Many Litecoin-copycats try to lure Litecoin sCrypt-miners to their coins, but that proves to be hard (but much easier than Bitcoin, due to the fact that many kids and amateurs, switch their relative cheap sCrypt-hardware for a few days to new networks to make a quick buck). In order to succeed, new coins need to attract Miners permanently (for security and supply) and it needs demand (which doesn't exist if it hasn't any major improvement). These copycat-developers try pump & dump schemes and are in no way competitive to Bitcoin (in contrast to what Tyler Cowen suggests).

Total shit, these people think they know it all, so why are we in the worst financial situation ever witnessed, in the modern world you would think these old boys would update their old grey matter.....these brain dead idiots are old and dead wood> NO ONE takes note of them anyway, most of the stuff they bang on about is all cloak and daggers with the grey matter lacking.

Change your record we heard it all before and its so boring.

unconvincing argument and article. I bought more bitcoin after reading it.

500 vs 400 doesn't matter to anyone when you are talking about a currency. Bitcoin is divisible, and can be made to be infinitely divisible. So if someone wants to spend 400 instead of 500 they will just buy .8 of a bitcoin. There would be no incentive to switch to a different currency. Only price stability or a great new feature would make someone switch, not the value. Doesn't matter if it's a million for 1 bitcoin and 1 dollar for another cryptocurrency.

And to the person mentioning greater adoption should mean lower should read my point above. The value of bitcoins does not fundamentally matter because they are divisible. A bitcoin is not like a house that is difficult to break up into pieces and sell. Bitcoins are divisible at no additional cost to the user, so the supply can accommodate anyone even for very small transactions. Higher price does not mean higher barrier to entry in the case of bitcoin.

It's not the first time that I see otherwise intelligent, cultured, knowledgeable and well meaning minds give in to the pressure of opinating on something they might feel they should know about but they do not.
Although I had never heard of Mr. Cowen before, he seems to have many tools in his bench, as far as economics is concerned. And yet, he uses generalizations that have often worked for him in the past, glossing over detail in the hope or the unwarranted assumption that detail doesn't matter and that he has seen it all already.
$50 per coin, i.e. 1.05bn marketing cost for Bitcoin? Come on, some reality check! Also, why would a druggie prefer to spend ten $50 Zitcoins instead of one Bitcoin to buy $500 worth of weed? It is just stupidity, unless you account for a possible tiny revaluation effect during the transaction lag.
Also, like pundits much less educated than he is, Mr. Cowen talks about the Crypto deflation monster. BTC is currently not deflationary but inflationary, since Satoshi's printing presses are humming along nicely. It will be deflationary when the worth of merchandise starts being measured in Bitcoin if by that time it is still encountering growing demand, and deflationary in earnest if it makes it to the fateful 2140.
I have no idea if my paltry collection of toy Bitcoins will be worth their weight in silicon in a few months, but his concluding statement is a non-sequitur from the vague noises over marketing expense, marginal cost and other misused paraphernalia from Samuelson's book he brandishes here.

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