Justin du Coeur (jducoeur) wrote,
Justin du Coeur
jducoeur

This week's object lesson is finance and economics

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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