Virtual currency Bitcoin has been on a wild ride lately, rising in price from around $50/BTC early March to $260/BTC mid-April, before crashing back down to earth just days later.
This clearly constitutes a speculative bubble, similar to the Dutch “Tulip Mania” of the 1600s. Tulips became a popular flower among the Dutch aristocracy, which caused a steady rise in prices, which led to increased interest from speculators, many of them French. Traders met in taverns to buy and sell tulip futures, paying just a 2.5% “wine fee” to trade. At the peak of the bubble, a sale of 40 bulbs fetched 100,000 florins; by comparison, a skilled laborer might make 150 florins per year! The Dutch traded their possessions, too: a man offered 12 acres of land for a single rare bulb. Another man gave away literally all his things: huge sums of wheat, rye, butter, cheese, beer, wine, four oxen, eight pigs, 12 sheep, and the list goes on, again for just a single bulb! The value peaked before the end of the year, and then fell to one hundred thousandth of its value overnight, before any of the bulb contracts even shipped! Many citizens were made rich; many others were up one tulip bulb or one contract, but down a house, a life’s possessions, or a fortune.
Where did the Bitcoin bubble come from? Was its source as inane as a fashion trend, or is there something big to this up-and-coming technology? I argue that the story all started mid-March in Cyprus. In talks regarding the struggling island nation’s financial woes, officials suggested an unprecedented “bail-in,” in which the government was to tax citizen’s bank accounts directly, by as much as 10%, to bail out Cyprus’s banks. Unsurprisingly, this triggered an immediate run. Banks placed a limit of 400 Euros on ATM withdrawals; still many ran out of cash. People were desperate to empty their bank accounts before the government could. And, it turns out, many turned to Bitcoin. Bitcoin’s initial rise coincides perfectly with Cyprus’s “bail-in” talks. The virtual currency is totally decentralized, meaning that no central bank can manipulate its supply. Only 21 million bitcoins will ever be produced. The amount in current circulation will gradually approach that number, reach it in 2140, but never surpass it. Suddenly, in a floundering Eurozone, even a third party, peer-to-peer cult currency seems more attractive than the Euro.
In fact, Bitcoin is appealing in the midst of any sort of financial instability. The Cypriots aren’t the only ones whose bank accounts may soon lose value. Sure, they’re the only ones who have had to face a direct tax on their accounts. But the same end is achieved through money-printing by a central bank! Greater supply of money causes inflation, which causes those who have saved to lose wealth. In countries where monetary policy is regulated by a central bank, you could lose your savings, whether they’re held in the bank or in a mattress. Therefore, simply the anticipation of inflation is reason enough to move your fiat money into something else: real assets, perhaps, or Bitcoin.
Bitcoin doesn’t have the intrinsic value of gold, real estate, or even the tulip. But it does offer the prospect of long-term stability due to a hard-set money supply. Bubbles like last week’s might cause short term fluctuations, but the price should stabilize in the long run, especially as liquidity improves. Of course, gold prices might be relatively stable too. But, unlike gold, Bitcoin offers the potential to trade nearly instantly, internationally, anonymously, and without the help (or hindrance) of any bank. Gold could never directly replace dollars, but Bitcoin could. The sole true measure of Bitcoin’s value as a currency is the extent of its acceptance among merchants, which, at this point, is frankly pretty low. But there’s plenty of reason to believe that Bitcoin acceptance will rise drastically in the future. Governmental policies like those in Cyprus, or in the Eurozone in general, or even here in the States, may leave us no choice.