Bitcoin is Collapsing

Ars Technica has a nice writeup regarding the steady fall of Bitcoin’s value:

Unfortunately, the currency’s value hasn’t proven stable in practice. Several waves of media coverage between April and June pushed the currency’s value up from less than $1 to more than $30. Soon after it reached a peak, the currency had a series of PR disasters. One Bitcoin user claimed that a half-million dollars worth of Bitcoins were stolen from his PC; he may have fallen victim to Bitcoin-stealing malware. A few days later, the most popular Bitcoin exchange was hacked, forcing a multiday suspension of trading and generating another wave of bad press.

Trading resumed in late June at around $17, and the currency’s value has been steadily declining ever since. In August, one of the most popular Bitcoin “banks” claimed it had been hacked, and had lost hundreds of thousands of dollars worth of Bitcoins, triggering a fall in value to under $7. Bitcoin fell below $5 in September, and it is now worth less than $3.

So is Bitcoin doomed? The value of Bitcoins is (like any fiat currency) ultimately driven by supply and demand. With dollars, the supply is controlled by the Federal Reserve, and the demand is driven by the size of the US economy. The supply of Bitcoins grows automatically, asymptotically approaching 21 million, and the demand for Bitcoins is driven by the volume of Bitcoin-denominated transactions.

Many people in the libertarian movement have been excited about Bitcoin. I know some people who have invested quite heavily in the electronic currency and thus far have no real value to show for it. The surge of Bitcoin supporters in the libertarian movement confused me as most libertarians are proponents of commodity backed currencies. We support commodity backed currencies because it means there is real value tied to our money in the form of the commodity. For example silver is used in numerous industrial processes which makes it valuable. If you have silver you can easily state that it has value because it’s used to produce other things. Even if it isn’t chosen as money it can be traded to those who utilize it just as gold, gasoline, and food can be.

Bitcoin is backed by nothing, which makes it yet another fiat currency. The United States dollar is a fiat currency that enjoys commons use because other countries have chosen to back their fiat currency with dollars and because the federal government requiers you pay all taxes, fines, and payments to them in dollars. If you don’t have dollars you can literally go to prison come tax season. In essence the dollar has value because a gun is put to your head saying it does. Bitcoin doesn’t enjoy this benefit either so it’s really only worth what people are willing to pay for it.

As it sits now there is a chicken and egg problem with Bitcoin. Bitcoin can only be valuable if people accept it in payment for actual goods and services but nobody wants to go through the hassle of accepting it until enough customers want to pay for their goods and services in Bitcoins. There is no intrinsic value in Bitcoins as they are nothing more than bits on harddrives and networks so the system doesn’t enjoy the benefits of commodity backed currencies.

I believed from the beginning that Bitcoin was an interesting experiment that could, eventually, lead to greater things but will likely peter out in its current form. Part of the reason I predict doom and gloom for Bitcoin isn’t just the fact that it’s a fiat currency but also because the government has a knack for shutting down any potential competition for the Federal Reserve dollar. Reading the news of Bitcoin’s downward value slide it appears as though the government won’t need to resort to legislation to put Bitcoin down.