The Problem with Bitcoin
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their employees and contractors, and so on. It does what it can to keep the currency stable. Bitcoin does not have a central bank, so it’s technically not a currency. If it were, it would be failing miserably.
Hyperinflation is bad enough. Germany, Argentina, Iceland, and others—anybody who has experienced hyperinflation never wants to see inflation again. But hyperdeflation, as Bitcoin regularly experiences, is even worse. Central banks will do everything they can to avoid deflation because it means that people will avoid buying things and drag their feet on paying. They will do business just by keeping their cash under the mattress. No business! Latte, anyone?
If Bitcoin doesn’t qualify as a currency, perhaps you could think of it as a service—an intermediary for certain kinds of transactions. That would make sense. With Bitcoin I can execute risk-free transactions with someone on the other side of the world without involving banks or credit card companies. That’s value! There are probably a number of people who are willing to pay for that. After all, I pay the credit card company several percent on each purchase I make.
But why should the value of this intermediary currency fluctuate so wildly against all real currencies? Say you’re a startup trying to build a transaction management service, a kind of Skype for Bitcoin. It’s not at all helpful when the proprietary, underlying currency goes haywire. The nuisance of doing exchanges via a wildly fluctuating Bitcoin outweighs the cost of going through banks and credit card companies. If Bitcoin is a transaction service, then the rollercoaster Bitcoin exchange rate is a bug in the architecture. And now with so many people stockpiling Bitcoins, betting on a rise in exchange rates, it’s going to be hard to fix.
The only other reason I can think of for the dizzying ups and downs in the value of Bitcoin is tulip mania. Bitcoin has gone tulips!
In Netherlands in the 1600s, people started trading rare, fancy tulip bulbs and the prices went up. Bulb buyers would buy and stockpile bulbs, creating scarcity, driving up the prices. Soon prices skyrocketed, attracting even more buyers. Economists call it market froth: the beginning of unsustainable rates of asset price inflation. A few tulip bulbs could buy an estate. A single bulb cost more than a craftsman would earn in several years. The market escalated for years and crashed in weeks. This sounds like my best Bitcoin theory so far. Did I miss something? Someone, give me a better explanation!
Now, Bitcoin has some really neat, useful, advanced technology that might break new ground in finance. But I fear that a crash of Bitcoin will leave such a stink behind that nobody will want to touch it for a while. Just like we did with Internet companies after 2001. And that’s an outcome no innovator could wish for. Let’s treat Bitcoin as what it is—an impressive technology, a financial experiment, a social phenomenon, but hardly the basis for a new digital economy.