Is too much investment killing Bitcoin?

March 3, 2014

The function of Bitcoin

Let me pose an important question: What precisely is it that we want Bitcoin to do?  Is it a secure peer to peer transaction system as it was envisioned in 2009 or has it recently been forced to undergo a metamorphosis? Has Bitcoin now become something that its developers never intended it to be?

Bitcoin, since its launch five years ago, has enjoyed massive publicity and has become widely accepted as a secure means of exchange.  A cursory glance at the stats will show a tremendous success story but take a deeper dig into the figures and another tale begins to reveal itself.

Is too much investment killing Bitcoin?

The problem

The value of Bitcoin climbed in 2013 from just over $13 in January to $752 at the end of December.  This is an approximate growth of just under 6000% in a world where few very banks were paying a return of over 5% on deposits.  If you had cashed out in early December you would have got over $1,000. People are coming on board, investors are coming on board, and the media is coming on board. There is a rule in economics that “Good money pushes out bad money” and that seems to have been happening with our friend, Bitcoin.

A reasonable person: If a reasonable person, like you, who finds themselves to be in need of a laptop, had come into possession, or had had possession, of 100 bitcoins on January 1st 2013, and assuming these bitcoins had a fiat value of $1,350. Then that person could buy a computer to that value using their bitcoins. If that reasonable person was either, cautious, disorganised or indecisive and put off that purchase for one month then their bitcoins had climbed in value to $1,950. They could now buy a computer, assuming that prices in dollars remained stable, and have either $600 or 30 bitcoins left (change). On December 2nd, they could have bought the same dollar value of a computer for just 1.3 bitcoins.

People had a choice, would they keep their bitcoins, which were skyrocketing in value, or would they spend them? Reasonable people made the decision to spend their Dollars, Euro, Pounds and Yen and hold onto the bitcoins they had. This has led to widespread hoarding of not just bitcoins but cryptocurrencies in general, and while that makes sense for individual investors, who value a 6000% return, it has the effect of removing bitcoins from circulation. Bitcoin is by definition a currency with a capped maximum circulation of 21 million coins, if items are priced in Bitcoin and the number of coins in circulation then falls, then the value of a bitcoin must rise and also the volume of transactions will fall. As investors took over Bitcoin in the hope of short term gain their actions led to a level of reduced transactions but this fact was hidden from cursory observations by the increased value of the reduced number of coins.

Bitcoin can exist as a medium of investment, we have seen that in 2013, it can also exist as a medium of exchange and we see that on a daily basis too. I would argue that it cannot do both well. As investors move out of an overpriced bitcoin we will find that the volume of transactions begins to rise and the value, in dollars, begins to stabilise. This will, however, have the effect of rendering mining less efficient in the short term. In the longer term, we can reasonably assume that newer technologies and faster processing speeds will be available.

Maybe it is time to tackle the idea of the bitcoins that are supposedly in circulation, but have, in fact, been either deleted or lost? Remember all the computers that have been dumped since 2009, did everyone remove their bitcoins? Maybe we should give some thought to this and how to resolve it. Maybe Mt. Gox will shed some light going forward on how we should deal with lost bitcoins.

Last modified (UTC): March 3, 2014 11:42

PJ Delaney @P.J. Delaney@delboyir

Masters in Public Administration, Bachelors in Mgt., I live in Ireland, I have a bit of a background in Economics and lots of opinions on everything else.