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This week's object lesson is finance and economics
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jducoeur
I was wandering through Business Insider this morning, and stumbled across the news that Bitcoin's value has fallen through the floor, in record time. I can't say I'm surprised.

Quick background, for those who are new to the concept: Bitcoin was invented a couple of years ago (rather secretively) as an alternate, math-based currency. The idea is that you "mine" new Bitcoins by solving mathematical problems that take some real computer power, and that the problems get harder as time goes along. IIRC, the ultimate stock of Bitcoins is finite, but is designed to gradually make its way out there, providing folks with incentive to get involved with it. It's become mildly popular in some niche markets.

They've also got a brief but decent article on why Bitcoin is *not* just like any other fiat currency, much though it's promoters would like to claim that it is. It's largely correct, but kind of oversells the case, because it misses a key aspect of economics: all currencies are, at a certain levels, simply memes.

That is, no currency truly has "intrinsic" value. The article makes the case that fiat currencies have value because governments say they do, but plenty of collapses demonstrate the limits of that. And they ignore the more important comparison, which is to gold. I mean, gold's value really is a bit ephemeral -- it has value mostly because (a) it is pretty, and (b) it is in distinctly limited supply. Bitcoin did a nice job of mimicking the limited-supply part of that, although it can't match the "pretty" part.

Ultimately, though, gold has value because it has *always* had value, so everybody *believes* it has value -- and moreover, everybody believes it always *will* have value. That's why, in uncertain economic times such as recently, it tends to get more expensive: everyone knows that gold will always be valuable, right?

That trick works nicely right now, and will continue to work -- pretty much until the moment when it doesn't. Bitcoin was in a *massive* bubble, and that bubble has now popped. It popped faster than maybe anything has ever done previously, because there was nothing to prevent the pop. With a currency that is entirely notional, and traded entirely online, it means that pretty much *everybody* can panic simultaneously, sell their stocks immediately, and the prices go splat. It's the same process as any other bubble popping, just faster.

But it's pretty much the same as any currency in most important respects -- in particular, it has value only insofar as enough people think it has value. Once enough people holding it stopped believing in it, it goes *poof*. Whether it survives at all will depend on whether enough people continue to believe in it, and are prepared to ride out the wave of devaluation. Pace the arguments in the linked article, exactly the same thing happens in fiat currencies -- it just happens illegally through black markets when people stop believing in the currency...

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I think you understate gold's value to humans slightly. Setting aside its industrial value, which is considerable, saying "it is pretty" is rather dismissive of humans cross-cultural, ten thousand year penchant for jewelry.

There's a common tendency for us to just classify things as "memes", and treat them as if they were ideas that came up arbitrarily. The value of gold to humans is not merely an arbitrary meme, but one based rather solidly in our psychology - it is a logical consequence of the nature of our brains and the properties of the material, rather than something we decided "just because" one day that's stuck.

Edited at 2013-04-12 01:46 pm (UTC)

I honestly don't know if I buy that. Gold has one clear traditional thing going for it: it was the metal that didn't tarnish. Especially in antiquity, that was no trivial matter.

But I do think there's something a tad arbitrary about it. There are many fine substances for making jewelry, and yet we tend to fixate on the ones that are scarce in substantial part *because* they are scarce. And there are many valuable substances -- many vastly moreso than gold -- and yet almost nobody talks about using them as the basis for currency.

So in this case, I'm actually using the term "meme" pretty deliberately and precisely: the notion that gold is The One True Hard Currency (which heaven knows is still a very common notion) seems to me to be grounded more in ancient cultural habit than anything else. The idea made some sense originally, but I'm not sure that's been all that true for centuries now.

(Not that I'm saying anything especially radical here: this is part of the rationale for fiat currencies in the first place...)

Gold is more than a meme for currency. It's become a term of value in and of itself. Gold cards, gold records, gold medals, golden arches (only partly joking on that last one). So much so that we've had to come up with new appellations for things deemed better than gold (even in our language we have inflation...): Platinum albums, Black cards, Diamond rewards, etc.

It sounds too much like the virtual "money" found in MMORPGs and the like. For a while, I think the "Linden Dollars" in Second Life had a fluctuating exchange rate with IRL money--until some countries wanted to try and regulate it. I didn't keep up with the issue, though.

According to https://twitter.com/LindenWatch:

The Lindens rate just changed! Best rate to sell L$ for USD is now 257.9 L$/USD.

Updated 9 minutes ago.

And gold's slipping too.

Lean times => folks clamor for things they think will hold value. And those that got into the Ponzi scheme early, plus the brokers, always loudly bray that they are 'safe'.

Bah. Mortals.

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Yeah, I was sort of thinking that. It somehow fits their legend...

Yes, there is a fixed final amount of bitcoin.

One thing that troubles me about it is that there is a definable loss rate. Bitcoins are stored in encrypted digital files. There has to be some percentage of these 'wallets' where the owner lose the key, or the file gets lost. So deflation is an inevitable consequence in the long run.

So while the value has plummeted now, if the meme holds, there will continue to eventual value creep.

Although, I'm in favor of any incentive like this that encourages people to keep backups and secure password systems in place. Crashplan and LastPass for me, thank you.

Mmm -- good reminder for me to get Backblaze installed on my new machine.

And interesting point about the loss rate. I haven't seen that mentioned before, but it seems like you should be correct...

http://www.npr.org/blogs/money/2011/02/07/131363098/the-tuesday-podcast-why-gold this article has a great discussion on why gold came out on top. A lot of it comes down to chemistry and the ease of which it is to work with, does not tarnish and so forth..

It's pretty. And it has important industrial applications. And it's limited. And, oh, it makes decent coins.

But historically, gold is the only substance that has held its value as a currency through the ages. It's extremely inert, too, which is a helpful thing in a currency substance if it's to have any long-term success.

More thoughts in my head but I need to go deal with dinner.

Hm. I saw that Bitcoin news too and it just amazed me that Bitcoin ever got as big as it did without anything solid behind it. Did you ever read For the Win by Cory Doctorow? This post reminded me of it. It's a free e-book, very good I thought, though it falls apart a bit at the end. It talks about online economies a lot.

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