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It’s so rare that one can see economic theories tested in real time, but it happened just last week. At 5:35 p.m. Eastern Time on April 9, exactly one week ago as this is published, Farhad Manjoo of Slate popped the BitCoin bubble with this linked article, killing it with love and injuring himself (or at least his wallet) in the process.
I’m not going to quote from either the beginning or the end of Manjoo’s story. Instead, I’m going to quote from the middle:
Three weeks ago, I began hearing about bitcoin everywhere I turned. One afternoon I had lunch with a partner at Andreessen Horowitz, the large Silicon Valley venture firm, who told me that he’d been fielding pitch after pitch for start-ups that offered bitcoin-related services. After lunch, I got an email from David Barrett, the CEO of the fantastic expense-reporting start-up Expensify. Barrett wanted to let me know that his firm would soon let people submit expenses and get paid by their employers in bitcoins. He explained that the feature wasn’t a gimmick. Bitcoin would be helpful for people who regularly submitted expenses internationally; other services—like PayPal—charge hefty fees for moving money overseas, but with bitcoin people could send money for free.
I made a mental note to start looking into a story about bitcoin’s apparent rise to legitimacy. But before I could get started, bitcoin took over the media. Henry Blodget was calling bitcoin “the perfect asset bubble.” Felix Salmon published a lengthy treatise on why the bubble was sure to burst. The New Yorker spoke to some of bitcoins’ leading boosters about the future of the currency. Meanwhile the price just kept going up: Early last week the value of bitcoins soared past $100 each. This week, it went past $200. If you want a bitcoin today, it will cost you about $235, and if you wait till tomorrow, it will be more.
Hence, my disclosure. No one is quite sure why the price of bitcoins has spiked so quickly, but one of the leading theories is that it’s been hit by what Quartz’s Zach Seward calls a “demand crisis.” The world’s supply of bitcoins is essentially fixed, but because people in the media keep talking about it, demand keeps rising. This leads to higher prices—and as prices go up, people who currently hold bitcoins develop greater and greater expectations for the currency. This causes bitcoin holders to hoard their stash, which further reduces supply, which in turn boosts the price and sparks yet more media attention—and the cycle continues until the bubble pops.
Thus, by writing about bitcoin, I’m serving, in some small way, to raise its price. And as of last week, that benefits me directly. Thankfully, my wire transfer to LocalTill went through; after taking its $21.51 processing fee, the firm transferred my $1,000 to Bitfloor, one of the many online bitcoin exchanges where people trade bitcoins for cash. I immediately put in a purchase order, and within seconds the deal was done. I was the proud owner of 7.23883 bitcoins, which I’d purchased for about $138 each. If I sold my coins now, my original $1,000 investment would be worth $1,700—not a bad return in less than a week’s time.
The bubble burst the next day. Bitcoins dropped to, if I recall correctly, around $35 apiece and now stand at $66. My guess is that Manjoo’s publishing this article on a big global website may well have been taken as a really good signal to sell.
What are the lessons of BitCoins (other than they remain a great tool, I suppose, for illegal dealings)? Is this evidence that government intervention and control is actually useful in preventing this sort of bubble? Is it evidence that a currency must be rooted in something of intrinsic value — if that’s even possible? Is it evidence that you can now legally get away with a Ponzi scheme so long as you create a digital currency in which people can speculate? Is it evidence that Farhad Manjoo is an idiot?
So go read the story and enjoy a hearty helping of schadenfreude on the side. (By the waym “greater fool” theory, as name-checked in the title, refers to something other than mere idiocy; there’s no question that, here, Manjoo was the “greater fool.”) Your thoughts, as on most issue of monetary police, are of course welcome!