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Wednesday, December 18, 2013

Bitcoin Tanking after China Restricts It

Bitcoin hit $1000 a week or so ago, and everyone was hyping it as the greatest even for the cryptocurrency since its inception.  Now, after China's announcement that financial institutions can only trade in the national currency, the Chinese Yuan or Renminbi, the price has dropped to approximately $500, and is experiencing higher than normal volatility.  This brings up some very interesting aspects of the cryptocurrency that I feel deserve comment.

Many of the people I have met online that talk about bitcoin seem to believe (or want others to believe) that it is a magical thing that will always increase in value.  The term "magic" is in reddit's r/bitcoin/ 's advertisements (featuring a horribly drawn wizard and the phrase "magic internet money").  Stories posted in that subreddit also talk frequently about how stores and businesspeople are getting converted, and start accepting bitcoin, often using that same word "magic."   There's nothing "magic" about bitcoin.  Cryptocurrencies have some unique properties compared to other currencies, but bitcoin is not unique in being a cryptocurrency, there are dozens of other coins out there (albeit none as mainstream as bitcoin is).

The way bitcoin is being pushed makes it seem like a ponzi scheme.  For bitcoin to become successful, it needs a wide acceptance.  Currencies are only effective as a means of exchange, and the areas you can exchange them for goods or services are limited.  No major retailers accept them (save through workarounds, like a service that purchases amazon giftcards with cash and takes payment in bitcoin for those cards).  At the moment, then, it is little better than a bartering tool between a relatively small percentage of people.  Currently, its primary value is as an investment and a trading commodity, which means that the more demand created for them, the higher the price will go.  This is why some are pushing so hard to get anyone they can interested in bitcoin.  The more people wanting to buy, the higher the demand, and the higher the coins they own will increase in price.

I see one of several potential futures for bitcoin, none of them good.

1. Bitcoin does not fully recover from this selloff.  It does not rise above $1000, and people lose interest in it, as it will lack the massive profits that got it so much attention.  It will be one or two more significant pieces of bad news away from obscurity (such as the US/EU taxing it heavily or outlawing it).

2. Bitcoin recovers from the selloff, and continues as before.  Eventually a piece of bad news will cause another crash.  Lack of stability will keep bit retailers away, and prevent the currency from becoming mainstream enough to accomplish its goals.

3. Bitcoin doesn't recover at all from this selloff.  Prices plummet, and bitcoin is a goner.

4. Bitcoin recovers, survives all bad news that comes its way, and becomes accepted by some mainstream retailers.  The US/EU/China never accept it as a central currency, but tax and regulate it.  It is legal to use as a means of exchange.  The last coins are mined, and many hashing machines are turned off because it is no longer profitable to run them.  The fast reduction in hashing power causes transactions using bitcoin to lag, taking a long time to process.  People stop using bitcoin as much because of this, which reduces transaction income.  This reduction forces more hashing machines to shut down, causing a downward spiral that kills bitcoin.

I'm thinking that 1 is the most likely scenario.  The price should rebound slightly, but it will not last.  China was a huge market for bitcoin, and unless they reverse their decision, then things will take a long time to get better.

-VG