Update 3: I've decided to start trying to keep a blog again. I no longer use
Tumblr, and I don't intend to try to reconstruct the entire old blog, but as
this post is the very first "Bitcoin obituary" listed on
99bitcoins.com, I
figured I'd put it back up for posterity's sake (and so that nobody thinks I
took it down out of embarrassment). Read the other updates; even with the
latest crash I remain convinced that cryptocurrencies have a future, so I'm
also not putting this back up as an "I told you so." I still think I was
originally wrong.
Update 2: Since trolls can’t seem to resist posting comments on here to make
themselves feel smart, if you bother to read anything on this blog besides
this post you’d see that my second post on Bitcoin, which is clearly
supportive of it, was made before the second “obitiuary” on 99bitcoins.com and
probably long before you’d even heard of Bitcoin. If you’d heard of Bitcoin
when I made the original post and weren’t a skeptic, you’re either way smarter
than I am or not that smart at all.
Update: Since I posted this, I’ve been convinced that due to its unique
properties as a purely digital, scarce, easily transferred artifact, Bitcoin’s
exchange value is probably enough by itself to prevent a deflationary spiral
to zero. See this answer I posted on Quora.
I wasn’t going to make a post bashing Bitcoin, because their FAQ clearly
states that its value only stems from the fact that merchants are willing to
accept it. Unfortunately, this hasn’t stopped people from pushing it as the
currency of the future, so regretfully, I feel compelled to post why this is
not so.
While Bitcoin has managed to bootstrap itself on a limited scale, it lacks any
mechanism for dealing with fluctuations in demand. Increasing demand for
Bitcoin will cause prices in terms of Bitcoin to drop (deflation), while
decreasing demand will cause them to rise (inflation). What happens in each of
these cases?
Let’s start with deflation, because right now demand for Bitcoin is on the
rise. What do people do when they think something’s value will be higher
tomorrow than it is today? Well, they acquire and hold on to it! Who wants to
give up money that’s constantly rising in value? In other words, rising demand
causes demand to rise further. Irrational exuberance at its finest. Deflation
begets deflation, ad infinitum, or at least until something breaks. You could
make lots of money on Bitcoin, provided you get out of the market at the right
time.
Eventually, of course, prices won’t be able to fall any further. Either people
won’t be spending their Bitcoin anyway because they’re making so much money
just by holding it, or the merchants will get tired of changing their prices
every few seconds, assuming they don’t hit technical issues first, like the
indivisibility of coins or their software not being able to handle all the
zeros after decimal points.
At this point or shortly before, people will start taking their
profits. They’ll start spending or selling their hoarded coins. If this
manages to start any inflationary momentum at all, you’ll see the deflation
scenario played out in reverse. And who’s going to stop it? The supply of
Bitcoin is fixed and there is no other use for it besides as a currency. I
doubt prices will have much of a chance to rise, since this will happen so
fast. Merchants will go from taking one coin for a year of porn to not taking
Bitcoin at all, and a bunch of people will be left with worthless Bitcoin.
The reason this can’t happen with government currencies is that government
currencies are backed. They’re backed by bullets. If demand for USD starts
to fall faster than the USG would like, the USG can just raise taxes without
increasing spending, increasing demand and reducing supply
simultaneously. There’s a bunch of stuff the FED can do, of course, and the
FED tends to act first, but its operations are harder to explain. This is
obviously not a perfect mechanism, since bubbles are still blown and popped,
but even this mechanism is not available with Bitcoin.
Negative feedback loops like this are basically homeostasis. In nature,
positive feedback loops like exist with Bitcoin are lethal; the only thing
that’s even kept Bitcoin alive this long is its novelty. Either it will remain
a novelty forever or it will transition from novelty status to dead faster
than you can blink.