Bitcoin Prices Could Crash, Again
Although Bitcoin prices moved above $400.00 this week, another crash in the Bitcoin market is on the horizon. Investors are getting bullish on Bitcoin this week, but the reasons make no sense. In fact, the entire premise of Bitcoin mining is deeply flawed.
There are two main arguments in favour of Bitcoins: that it is a perfect payments system that it is an ideal currency. There are complex arguments on both sides of the Bitcoin fight, but I don’t see any justification for this random surge in Bitcoin prices.
That being said, I don’t want to dismiss the Bitcoin advocates as a bunch of crazy anarchists; they’re technological futurists that include heavyweights like Ben Horowitz, a venture capital kingpin in Silicon Valley. (Source: “A Bet Over Bitcoin,” NPR Planet Money, February 5, 2014.)
If you’re unfamiliar with Bitcoins and Bitcoin mining, don’t get discouraged. Bitcoins are basically a digital currency with no central authority. It exists as a network on the Internet, thereby removing banks and their fees from the transaction process.
Things get tricky when we start asking how Bitcoin currency got started. Where do new Bitcoins come from? What does Bitcoin mining even mean? First let me answer those questions, and then I’ll explain why Bitcoin is doomed to fail.
Bitcoin Mining in a Libertarian Utopia
Bitcoin mining is how new Bitcoins enter the money supply. By solving a mathematical problem embedded on the Bitcoin network, a “miner” can win a certain block of Bitcoins. From that point on the Bitcoins can be bought or sold on exchanges, traded for traditional currency, or taken out from a Bitcoin ATM (yes, those are a real thing).
However, there is an upper limit on the amount of Bitcoin mining that can take place in one year. Every few years, the number of new Bitcoins will halve until the final allotment sometime near 2140. The supply of Bitcoin currency is finite.
Oddly enough, that’s why Bitcoins have a cult following. A lot of people think that central banks cause irreparable damage to a country by freely using the printing press. And then there’s the efficiency of a frictionless payments system that allows electronic money transfers with no third party taking any fees. Banks become irrelevant.
Of course, cryptocurrency advocates admit that Bitcoin currency needs to become more widely accessible for its value to stabilize. If merchants don’t accept Bitcoins as a means of payment, then the whole argument is moot.
Why Bitcoin Currency is Doomed
As a payments system, I don’t have much against Bitcoins. It is kind of ridiculous that we pay a bank to hold or transfer our money in an age where the Internet is ubiquitous. But the money supply issue is a fatal flaw for Bitcoin currency.
A fixed money supply is a bad idea and anyone who argues differently is ignorant of history and economics. Remember the gold standard? Yeah, the money supply used to be bound by a finite supply of gold. Then the Great Depression happened.
Using the type of central bank system we have today, the money supply can be increased to help cushion the blow. But holding a finite supply of money, like Bitcoin advocates are in favor of, would cause massive deflation in the economy.
Even if you disagree with that line of reasoning (which is Econ 101), then understand this simple point: why would the existing central banks of the world not regulate against Bitcoins currency? All they have to do is denounce the convertibility of Bitcoin to their currency and the game is over.
No merchant will risk accepting Bitcoin if they can’t be transferred back into their own currency. Even if they could pay their grocery bill, rent, and utilities using Bitcoins, there’s still the small matter of taxes. Ultimately, central banks need the authority to ease the pain of business cycles. That’s why Bitcoins are no more than a Libertarian pipe dream.