The idiots normally call me names when I post about Bitcoin, but here’s an article by Heather Morgan, an economist and author who formerly worked in emerging markets, now doing economic consulting for startups, that happens to be popular on Hacker News — A Lesson in Economics for Engineers (for idiots, actually):
No matter how brilliant or elegant an asset may sound to investors, it is as vulnerable to financial crises as any deregulated financial market. Whether e-gold or the derivatives of the US subprime mortgage market, bubbles follow the same patterns for growth and implosion. Bitcoin is an extremely volatile asset by nature because its value responds directly to the market’s demand, increasing the exposure to speculative attacks.
Although some saw Bitcoin as a revolutionary currency, it’s actually not a real currency, but instead a volatile asset. Fiat currencies (money) are pegged to real assets and backed by governments, which give their valuation credibility. However, since Bitcoin has no legitimate peg, government backing or regulation, its value rests with the demand of its buyers, holders, and the willingness of merchants to accept it.
Some may argue that money also has no inherent value, and that precious metals like gold initially had value because they were multi-purpose and could be melted down for other uses. However, assets are only valuable as long as they can be traded for liquid cash or other goods and services, and Bitcoin has no other use other than as a cyber currency. Bitcoin mining is not valuable for anything other than creating Bitcoins. Bitcoin is possibly the most valueless asset in history. If people no longer wish to hold or accept Bitcoin, the value will be exactly zero since it has no inherent value, making it an extremely fragile asset.
The value of Bitcoin relies on the holder’s ability to sell it on exchanges (or not). If exchanges go out of business or have outages the value plummets. If enough Bitcoin exchanges were to disappear, the value of Bitcoin crashes (as we are seeing now with Mt Gox), and those holding Bitcoin are left holding a rapidly depreciating asset that may reach a zero value and collapse (look at e-Gold).
Because Bitcoin does not have government backing, Bitcoin holders are not protected. Mt Gox has been the biggest exchange for Bitcoin, and it’s all anonymous. What would prevent them from eventually seizing or stealing assets on the exchange? Likewise, because Bitcoin does not work through a bank, there is no protection for Bitcoin holders against fraud or their wallets being hacked.
The Mt Gox exchange already moved their office to a virtual location. With anonymity built into the very nature of Bitcoin itself, it makes it easy for the guys at the top to make off with their millions and disappear into cyberspace (or the British Virgin Islands).
While it is difficult to predict the exact time window of when Bitcoin’s value will reach zero, but it will happen sooner or later because it is a fragile asset which retains no real value. Bitcoin will become a lesson in economics textbooks of the classic bubble riddled with scams.
I’m an engineer, not an economist, but all this — and much more — was clear to me from day one.