The price of the electronic currency Bitcoin continues to soar.
Six weeks ago, Bitcoin was trading at $35. Since then, the price has continued to surge to new highs. Just this morning, Bitcoin blasted through $250.
As is always the case with such price moves, observers have been dismissing Bitcoin as a "bubble" since long before prices even hit $35.
And the observers may well be right.
Bitcoin may be a bubble.
Someday, Bitcoin prices may come crashing down, causing the suckers who own them then to lose their shirts.
But, in the meantime, those who are speculating in Bitcoin are just laughing at all the people who are dismissing Bitcoin as a bubble. These speculators have made 7X their money in six weeks, which is a return that more than justifies the risk they took of potentially losing everything. (As long as the chance of each outcome is roughly the same, downside of 100% and upside of 600% is a great bet.)
Like the assets at the center of most powerful asset bubbles, Bitcoin has sound theoretical underpinnings. The world can benefit from a convenient global electronic currency that is not subject to the whims and political incentives of governments trying to get themselves reelected.
Importantly, Bitcoin also has a small and (at least theoretically) finite supply. So the more demand for Bitcoins increases, the more the price of Bitcoins should rise.
Of course, as in any bubble, the more Bitcoin prices rise, the more demand there will be for Bitcoins. Bitcoin buyers may tell themselves stories about how they are buying a "store of value" in an inflationary world, how Bitcoin is a "good investment," and so forth, but these stories will seem much less compelling if Bitcoin prices suddenly drop, say, 75%.
If Bitcoin prices crash, all the folks who now think Bitcoin is a "good investment" will suddenly start crying bloody murder that they were tricked into buying something with no inherent value. And they will want to jettison their Bitcoins at any price someone will pay for them.
(This is just the way bubble psychology works. Sorry about that.)
In the meantime, though, Bitcoin prices could rise another 2X. Or 10X. Or 100X.
Because there's really just no way to figure out what a "fair price" for Bitcoin is. There's is theoretically a finite supply of it. And there is theoretically nearly unlimited demand for it. So there's no theoretical reason why Bitcoins can't eventually trade for $500, or $2,500, or $25,000. Or even $250,000.
And that means that brass-balled speculators will likely continue to plow into Bitcoin, as long as think it will continue to appeal to new speculators who haven't yet entered the game.
Because Bitcoins have no inherent value (only the value that they can be exchanged for, which is determined in large part by speculators), Bitcoin prices could crash permanently at any time.
So it's worth thinking about what might cause Bitcoin prices to come crashing down.
Here are some things:
- A sating of demand. At some point, everyone who could ever learn about or use Bitcoin will know about it, and many of them will own it. Given the lack of awareness about Bitcoin among the general population, as well as the complexity and "friction" involved in owning Bitcoin, we are a long way from this point.
- A drop in the price of Bitcoin (for whatever reason). Another thing that could cause demand for Bitcoin to drop is a Bitcoin price crash. If Bitcoin prices crash, many of those who already own them will not want to own them anymore--and they'll jettison them. This will cause a further price crash, which will further reduce demand. Etc.
- A Bitcoin counterfeiting or hacking or theft scare. Bitcoin aficionados will smugly tell you that Bitcoin "can't be counterfeited." Please. Anything can be counterfeited. To counterfeit something, you don't have to create the actual thing. You just have to create something that fools other people into thinking you have the actual thing. If there's a computer system out there that can't be hacked or fooled by a very clever hacker, I haven't seen it yet. Meanwhile, even if the Bitcoins themselves can't be faked, the systems that account for them can certainly be hacked. This has already happened. And if someone figures out a way to steal or delete or otherwise destroy all your Bitcoins, you will be much less likely to invest in them.
- A government crackdown on Bitcoins. If Bitcoin gains general acceptance, governments may begin to frown on it. After all, general acceptance of Bitcoin would usurp the governments' sole authority to create legal money. Governments don't like having their authority usurped. So they may begin to enact laws that prohibit the use of Bitcoin.
- An increase in the supply of Bitcoins. Bitcoin aficionados will also proudly assert that only a certain number of Bitcoins will ever exist (21 million, if memory serves) and that no more can be created. Again, keep dreaming. The supply of Bitcoins as currently defined may, in fact, be limited. But there's nothing stopping the folks who created Bitcoin (or anyone else) from creating a new equivalent or better Bitcoin. Aside from the fact that Bitcoin appears to be well designed, there is nothing special about it.
- A better Bitcoin (or even just another Bitcoin). This is a very real risk, one that Bitcoin enthusiasts don't spend enough time worrying about. Again, there is nothing special about Bitcoin. Although awareness of it is growing, it's still complicated and hard to use. And monetary philosophers are already pointing out that the "finite supply" of Bitcoins may, in fact, be too small, limiting their usefulness. So if Bitcoin can gain traction, then so can any other electronic currency. And if another electronic currency begins to displace Bitcoin, the "finite supply" argument will go out the window. There might soon be a nearly unlimited amount of a better Bitcoin.
All of these factors--and many others--could cause Bitcoin prices to crash.
Bitcoin speculators would do well to remember that.
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