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April 3, 2013

BitCoin - is it a bubble?

Filed under: Uncategorized — admin @ 12:21 pm

There were three times in my life when I felt sure enough of my financial reasoning to recommend a certain investment to all my friends. The first was when Google went IPO. The second was some obscure moment in Microsoft’s history, and the third is very recent.

About a month ago I started recommending to all my friends to get bitcoins - fast. My reasoning went as follows:

  • BitCoin is a currency
  • Other things being equal, the value of a currency is tied to to how many people and organizations will accept it for things others value
  • We are only at the start, and more merchants are going to be accepting BitCoin every day, especially as it gets easier to do so
  • Other people will realize this soon, which will drive up the price of the currency.
  • I am typically among the middle-early-adopter when it comes to techy stuff, so if there’s a bubble, it still has a long way to go as BitCoin articles go mainstream

That was a month ago. And if you got BitCoins in the last month, you saw them gain a lot of value on the exchanges. But the question now comes up: with charts like this, is it a bubble?

In my opinion: Yes, but more importantly No! The meteoric rise of BitCoin is related to network effects because it is a medium of exchange. It is not unlike the meteoric rise of facebook or of pinterest. While Metcalfe’s Law has historically been too optimistic in predicting the value of a network based on its size, something like n log n is not at all unreasonable.

The fundamentals of BitCoin suggest that it is poised to grow far beyond where it is today, since more merchants means more users, and more users means more merchants. However, the hype surrounding BitCoin may push the markets far ahead of its current growth. So that’s where the danger of the bubble comes in. This is like investing in facebook in its early days and asking if it’s a bubble. At the end of the day, I think BitCoin has all the fundamentals to legitimately go to $10,000 or even $100,000 a coin. Whatever price you’re probably paying for BitCoin today will seem a bargain a few years from now.

All this leads many people to want to take a long term long position in it, which will drive its prices even higher in the next few months. In monetary terms, BitCoin is going to be hoarded for quite a while and experience massive deflation, which will have an interesting effect on its adoption by merchants. It’s very attractive for a merchant to accept a currency for their products that will be worth more tomorrow, so in short, both sides are incentivized to try to get BitCoin as its prices rise and rise.

We’re just at the beginning of the BitCoin craze. Now you may even be able to cash them out using ATMs in Cyprus. There’s a lot of opportunity around BitCoin and making it easier to trade them for actual things, but also a lot of regulatory risk up ahead.

On the other hand, if you care about BitCoin as a currency, you should probably be careful of Gresham’s law.

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  8. Ideally the concept is to rvmeoe the mess that has been created with factional reserve banking. Right now so much power is in the hands of the central banks. This power gives them the ability to control the amount of currency that is in circulation. In essence money is created out of thin air with no weight to it like the gold standard created. Money is built on trust in the value of that currency, which is very scary. You can even see in recent times how this type of system has created massive problems and will only get worse as time goes on. The only way I personally feel that currency can be fixed since we left the gold standard is to create a new currency with a relative value unit assigned to it. The relative value can be tied to something tangible. To supply a certain good or service it requires certain resources. Those resources being natural, human and others. For example it takes a specific amount of resources to produce a car. Machines, equipment, people working on it, natural resources like metal, plastics and time. These factors can be used to produce a RV for that car. Unfortunately I think there is so much money in circulation, that it would be near impossible to go back to the gold standard as there may not be enough gold available in circulation to match out the currency to. Why not create a balance of the commons of ALL available tangible resources and not just gold?The concepts I like of BitCoin are the fact that there is no central authority for currency. What you produce is what you own. You actually own that currency that you have produced using your resources and it has value based on the fact that others had to go through the same create that currency as you did. The idea of using CPU cycles is very geeky and not sustainable. The idea though that you have this resource and by using that resource you are producing something that holds value amongst those doing the same type of work place the value and trust in that currency. So when you go to work based on your education, work experience, skills, time spend doing your job, the actual work being done and even the value your employer feels you are worth to them can all be used as factors. That value of currency that you produce has no value that is set by factional reserve banking and the amount of currency in circulation. It is based on a true tangible asset like the gold standard used to be.Just my two cents.

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