The Lines in the Bitcoin Bubble Battle Are Drawn: What Side Are You On?

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As recently as March 1, a unit of the mystery money was trading for $33 ( USD ), having doubled its value since the beginning of the year. BusinessWeek's proclamation that it "may be the global economy's last haven" comes as the currency surpassed a $1 billion monetary base on March 28, and as of this writing, the exchange rate for an individual coin is netting north of $141.

In the last few weeks, the Web has been ablaze with a torrent of commentary about Bitcoin, the digital crypto-currency fruit of a pseudonymous Japanese hacker with a value that's accelerated higher than a North Korean rocket.

Not surprisingly, the ongoing cacophony that's had critics crying "BUBBLE!" from their balconies for months has reached a fever pitch in the past few days.

The lines in the sand have begun to be drawn, with many online pundits siding with 'fad' over 'fab.' Many have signaled their belief that Bitcoin's bull run will soon come to a predestined conclusion.

The Bubble Boys

Over at Forbes, Tim Worstall lamented Bitcoin's uselessness as a currency. Compared to the $15 trillion in US GDP that the dollar supports, Bitcoin represented a figurative blip -- it simply doesn't provide a base for enough economic activity to justify its current worth. Worstall is "reasonably certain that it will all turn out to be a bust in the end."

Other critics think the Bitcoin hoopla is too rooted in speculation as opposed to spending, potentially manifesting itself as hyperdeflation and posing as a deterrent to purposeful economic activity.

George Mason University economist Tyler Cowen has been a skeptic since 2011. One of the preeminent justifications for transferring one's assets to Bitcoins has been the system's anonymity, but Cowen doesn't see the advantage of holding Bitcoins over diamonds, let alone dollars in Cayman Islands bank accounts.

Plus, the true worth of Bitcoin's rise is mitigated by the fact that the currency isn't easily transferable into non-Bitcoin assets, Cowen noted.

There are only a few Bitcoin exchanges online and most of them are based in foreign markets where protections for traders are slim-to-none.

Even if Bitcoins were extremely easy to change into dollars, Cowen observed, "Then I will, and many other people will (there is a lot more wealth tied up in the Cayman Islands than in Bitcoin), and the velocity of Bitcoin assets accelerates. That encourages even more conversion out of Bitcoin assets. Why hold Bitcoin assets?"

Taken together, the bubble proponents' case can be summarized by three simple points:

1. Bitcoin does not support enough commerce to justify its worth. 2. It's not easy to short Bitcoin, let alone transfer between non-Bitcoin assets. 3. Rising Bitcoin values only encourage conversion out of Bitcoin.

To top it off, there's several other external influences that could drive a plunge in Bitcoin's value.

Bitcoin's $1 billion market capitalization is still small beans, meaning that network effects are amplified in a relatively tiny market. If one or two rogue investors decided to sell off a million Bitcoins, the act could send the market into a downward spiral back to zero.

Motherboard cites Bitcoin's technological vulnerabilities:

"Someone could conceivably take over Bitcoin mining, the process by which Bitcoins are produced and new transactions are verified and added to the blockchain, by commanding 51 percent of the overall processing power. Given the current rate hashrate, the combined processing power of all Bitcoin miners, such an event would require only a few million dollars investment."

While these crash-and-burn scenarios run contra the profit motive, there's always the chance of Bitcoin terrorism, too.

One can't rule out software glitches either, which are difficult to address in a Bitcoin economy, as its completely decentralized.

The U.S. Treasury has recently began to take notice of virtual currencies, paving the way for future regulations that may kill Bitcoin as we know it. As Motherboard noted, "[A] value transmitter outside the direct control of government could be viewed as a threat. And at some point, the U.S. could always play the, 'well this funds terrorism' card."

Bit Believers

With all these liabilities, why would anyone waste their time with digital dough?

As a basis, Bitcoin's viability depends on a justification for holding the digital money over conventional, fiat currencies. And to date, Bitcoin's largely succeeded in proving its worth in this arena.

For all the security risks listed above, Bitcoin's decentralized block chain -- which works similar to BitTorrent -- makes it nearly impossible to counterfeit. Its degree of anonymity is unparalleled, so there's virtually no risk of identity theft.

Since there's no credit cards and the business is the entity that swallows the loss if a payment is later reversed, there's little risk of fraud.

The hockey stick increase in Bitcoin's value has corresponded with financial instability in Cyprus, resulting in the state seizing deposits. Taking heed, the wealthy across Europe have taken a leap of faith in the online currency, particularly in Spain.

Like a Cayman Island bank account, Bitcoin offers the ability to park one's wealth offshore where governments can't get their paws on it.

Of course, there's also Bitcoin's popularity in the "deep web," where the online currency is utilized to purchase items of questionable legality on websites like the Silk Road, but the advantages to Bitcoin stretch far beyond shady activities.

One example where Bitcoin reigns supreme is international money transfers, where reimbursement charges cost virtually nothing, a vast improvement over eBay's (NASDAQ: EBAY ) Paypal charges of four percent.

Timothy Lee is a Forbes contributor who labeled Bitcoin a bubble as far back as 2011. But he's since come around.

Lee took time to address to Joe Weisenthal's claim that Bitcoin is entering a state of hyperdeflation.

"Deflation is harmful for conventional currencies because [they're] a unit of account as well as a medium of exchange...[B]ut Bitcoin is rarely, if ever, used as a unit of account. If you go to a website like Silk Road that sells stuff for Bitcoins, you'll generally find the prices listed in both Bitcoins and a conventional currency. The Bitcoin price is automatically adjusted as the value of Bitcoin rises or falls against dollars or euros...[S]imilarly, no one has Bitcoin-denominated salaries, borrows money in Bitcoins, or pays Bitcoin-denominated rent every month. So the rapidly rising value of Bitcoin isn't going to cause the kind of economic dislocations that dollar deflation would cause."

In response to Worstall, Lee asserted that, "the Bitcoin economy has a lot more potential for growth than a conventional national economy...[S]ince there will never be more than 21 million Bitcoins in the world, the only way the Bitcoin network could accommodate a higher transaction volume would be for each Bitcoin to be worth a lot of money."

According to Lee, the demand for Bitcoins is rooted in the belief that lowered barriers to entry and the lack of regulations are the perfect catalysts for commercially significant applications down the line.

There's no expensive or anti-competitive regulations that would prevent the establishment of new financial services and banks. All it would take is one Internet vendor to revolutionize the Bitcoin economy with a killer product, turning online currency into a staple.

In a sense, Lee's defense of Bitcoin is a bit of cop out. He believes Bitcoin may eventually support enough commerce to justify its worth, boosting the popularity of exchanges and reducing speculation or the incentive to transfer assets out of Bitcoin.

But the trendline is certainly on Lee's side. In the last two months alone, firms with big Web presences like WordPress, Reddit, Mega and Expensify have begun accepting Bitcoins as legal tender.

Perhaps the best argument against Bitcoin is that its rapid price expansion is not a good thing in the short-term, and that its value may soon drop to sub-orbital levels. There still aren't too many practical Bitcoin uses for the layperson and merchants need price stability.

But as long as the digital currency's forms of usage grow, becoming an accepted unit of exchange across more of the Web, can we really call Bitcoin a bubble?

As Scott Sumner accurately noted , "What does the term 'bubble' actually mean? One definition has to do with prices not equaling a rational expectation of fundamental values. But there's really no way of testing that definition. If you say you don't think the price is right, you've basically assumed the answer...[M]any bubble proponents don't...give [a] date. Then when prices rise after their prediction they brush it off, saying prices will later fall. If prices later fall they say it proves they were right, even if the later decline leaves prices higher that when the bubble prediction was made."

Is Bitcoin a bubble? Tell us what you think in the comments below!

(c) 2013 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy , International

Referenced Stocks: EBAY , USD

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