Source: Mark Rogowsky Forbes.com Contributor
The internet may have brought us unlimited sources of news and opinion, but the New York Times still has powers that few of the new generation can muster. Among those is the ability to claim two Nobel Prize-winning economists among its staff: the op-ed columnist Paul Krugman and Economic View’s Robert Shiller. Back in December, Krugman declared: “Bitcoin is Evil” and after the Mt. Gox exchange for the electronic currency declared bankruptcy in the past week, taking with it millions of investors money, some might argue he had a point. Shiller took that event as his chance to pile on Bitcoin while it was down: “ The central problem with Bitcoin in its present form, though, is that it doesn’t really solve any sensible economic problem,” he wrote in yesterday’s Times.
Schiller could scarcely be more wrong about that “central problem” thesis, which we’ll get to in a moment. But he does raise an important question about the wild gyrations of Bitcoin’s price over the past year. “The Bitcoin phenomenon seems to fit the basic definition of a speculative bubble — that is, a special kind of fad, a mania for holding an asset in expectation of its appreciation,” he wrote. “The instability of Bitcoin’s value in dollars is a measure of failure, not success.”
Jean-Paul Rodrigue , a Ph.D. who teaches at Hofstra University, came up with a model that defines the stages of an investment bubble. It looks like this:
Now here’s a chart of Bitcoin over the past year, using data from Coinbase, a leading Bitcoin exchange:
Keeping in mind that Rodrigue’s chart is a model, not a precise guide for what every single bubble is going to look like, reasonable people could argue that we’ve had the full run up to the “new paradigm” stage — and that the investment in so many Bitcoin companies, including Coinbase, attests to that — as well as the “return to normal” peak. But so far, what we haven’t seen at all is the fear from the Mt. Gox implosion leading to the capitulation and despair stages of Rodrigue’s model. They still might. And there are reasons why I believe that might be the best thing for Bitcoin in the long run, but it’s worth examining what is actually happening as best as it’s understood.
Where are the Bitcoins?
Because the price of a Bitcoin appreciated nearly a hundredfold over the course of 2013, the people involved in “mining” them and many who were trading them ended up holding onto their Bitcoins in the hope of ever-higher prices. An analysis at BitcoinTalk has concluded that as of the end of January, 8.8 of the 11.8 Bitcoins in existence are held by people with at least 100 of them. (At today’s prices, each of them has more than $50,000 in Bitcoin wealth.) Within that group it’s estimated that fewer than 1,000 people are holding more than half of the world’s Bitcoins and just 46 of them hold at least 10 thousand Bitcoins representing 3.6 million total coins — 30% of everything that exists. Given that there isn’t much to buy with Bitcoins yet, it’s reasonable to conclude most of those are held by speculators betting on higher prices.
That much consolidated ownership among people that don’t want to spend their Bitcoins isn’t good news and would lend credence to Shiller’s hypothesis that Bitcoin is nothing but a speculative bubble without much utility. But a deeper look tells a much different story. The same analysis was conducted just 3 months earlier and back then 9.3 million coins where in the hands of 100+ coin holders. In other words, 500,000 coins have moved down into more general circulation in the short time since late October. Better still, the number of people holding any Bitcoins at all has soared from 350,000 to more than 2 million.
It’s certainly possible these people are late to “tulip mania” but it seems more likely that they’re getting involved with Bitcoin now not to try to get rich from it, but instead to actually use it.
Wait, I thought it was useless?
Among the 25,000 merchants now accepting Bitcoin, are Overstock and Fancy. While proponents like Coindesk tend to get ahead of themselves with claims like “paying in bitcoin eliminates the need to enter personal information” — if you want something shipped to you, personal information entry will continue to be involved — the currency is gaining acceptance as a medium of exchange. For many of you, Bitcoin attempts to solve a problem in these cases you don’t have: Paying online by credit card.
But consider how many people do have this problem. First, everyone who for whatever reason can’t get easily get a card or is among the stunning 106 million who is “unbanked” or “underbanked” in the U.S. Second, consider those that are more mobile and need something shipped to an unusual location, but the merchant can’t accommodate goods going anywhere but to the address on the card. Third, consider the possibilities of high-dollar purchases where you might be willing to forgo the right to dispute the purchase in exchange for a discount of 2% from the merchant — the money they’d save not taking your credit card.
But what if the savings isn’t just 2%? What if the cost to the merchant is 10% or more just to process payment with a card? If you’re skeptical such businesses are out there, visit the website of ccBill. They process payments for the kind of web services no one else will touch. As ccBill describes it: “Some of these high-risk business models include adult online entertainment, live entertainment and cam sites, penny auction sites, as well as complex business selling. And now even dating sites fall into the high-risk category with MasterCard.”
Never mind potentially innovative ideas that people don’t even bother trying to get off the ground because they’ve been told by Paypal, Mastercard, or a bank that the chargeback risk is to great, so they shouldn’t bother. Enter Bitcoin, where willing consumers can choose to pay without having unlimited rights to decide later to “un-pay” and new opportunities abound. Yes, some of them will be nefarious schemes, but others will be like Bitcoin itself: Something that today is just a bit outside the mainstream, too difficult to understand until it gains adoption.
This is just the tip of the Bitcoin iceberg. Currently, it costs $8 to send $1000 to Guatemala with Western Union plus whatever they get on the currency conversion. With Bitcoin, the transfer itself is free. The only cost will be in whatever nominal fees the sender might pay to get Bitcoins in the first place and what it might cost the seller to turn them back into the local currency. These are already close to zero and the competition among Bitcoin exchanges is only in its infancy. In 2012, $478 billion in remittances, money transfers across borders, occurred globally. Not only is it hard to imagine Bitcoin failing to play a role in the market, it’s hard to imagine Bitcoin failing to gain a dominant position in it.
Bitcoin, too, is a natural for all sorts of underground activity like offshoring money either legally or illegally and quite possibly engaging in black-market trading for prohibited goods, as was the case with Silk Road, which was busted by the FBI. But to say, as Shiller does, these are not uses for the technology is to make a similar claim about the United States $100 bill, the preferred medium of exchange around the world for illegal activity. (Just ask Walter White.) And unlike many U.S. notes, Bitcoin is actually traceable. Everyone who is out there mining also stores an ever-growing ledger of all the Bitcoin transactions. While they don’t contain personally identifiable information, they do provide a breadcrumb trail of where the coins have come from and gone. If someone is up to no good, appropriate subpoena power and surveillance could be use to follow the money. That’s doable with paper currency only if you knew the serial numbers ahead of time.
Bit by Bitcoin
In the aftermath of the Mt. Gox debacle, what we’re left with has surprised many. Bitcoin’s price stayed stable in part because of the consolidated holdings. The speculators saw Mt. Gox as an outlier and didn’t panic. Without the bulk of Bitcoins being dumped, the price didn’t go into free fall. In the meantime, through a period in which the currency did indeed lose half its value from what might well prove to be a short-term speculative peak (from late last year through now), its adoption as a way to buy and sell things — and to move money — slowly began to rise.
Serious investors like Marc Andreessen of Andreessen Horowitz, who has aggressively taken to Twitter to defend and promote Bitcoin, and Fred Wilson of Union Square Ventures, who wrote a response to Senator Joe Manchin’s anti-Bitcoin tirade have put millions into companies that hope to profit from the growth of Bitcoin. That makes them less than completely honest brokers but more than mere self-promoters. They are basically putting their money where their mouths are. Without a robust set of well-financed exchanges, Bitcoin would likely fail.
With them, however, it starts to resemble a new kind of banking. One without a central authority, yes, but one with much lower overhead, too. Bitcoin isn’t designed to replace the dollar, the yen or the euro. That makes CNBC’s Larry Kudlow’s recent screed all the more mystifying: “[B]itcoin is not real money. It is not a reliable medium of exchange, nor is it a reliable store of value. It has no central bank regulation, network operations or even centralized issuance. And because of its wild price fluctuations, bitcoin can never be a reliable payment system.” But Larry, you can get Bitcoins for payments the instant you’re ready to purchase something, making you indifferent to the exchange rate. The merchant can turn those coins back into their currency just as quickly for a fee far lower than what they pay to take your credit card. Oh, and they get paid faster than a bank pays them too. Kudlow doesn’t have a Nobel Prize in Economics. But he’s every bit as off base as Shiller.