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Bitcoins and Bubbles

BY Jonathan Strickland / POSTED April 19, 2013
Hammerbrook - City can this really be true?
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It doesn’t matter if you’re using a computer, tablet, smartphone or humanoid robot to read this blog post — the device you’ve got is a number-crunching machine. Everything it does is the result of mathematical calculations. Games, music, videos, word processing — all of it comes to us courtesy of millions of operations between ones and zeros.

The bitcoin digital currency leverages the math wizard skills of computers by making it an integral part of how it records transactions and regulates the inflow of currency. Basically, every time someone spends a bitcoin — or a fraction of a bitcoin — that information becomes part of a larger chain of transactions encoded on the bitcoin itself. This information prevents someone from spending the same bitcoin more than once.

The digital record also creates a hash. It’s not a tasty treat you’d get at your local greasy spoon diner. Instead, this hash is the result of a calculation (or series of calculations) between various numbers. Imagine this math problem: X + Y = 15. You don’t know what X or Y is but you know what you get when you add them together. If you can figure out what X and Y are (essentially by submitting guesses), you’ll get a treat.

In the case of bitcoins, that treat is a lump of digital currency. The problems are way more complicated than X + Y = 15. In fact, they’re so complicated that your typical computer doesn’t have much of a chance to figure out a hash before someone with a far more sophisticated machine — or network of machines — beats you to the punch.

The math is what keeps the flow of bitcoins into circulation regulated. The more people try to search for bitcoins, the more complex the hash problems become. If people start to give up, the hash problems become less complex.

There’s a limited supply of about 21 million bitcoins total, though most of those have yet to be “mined” by computers performing hash problems. As computers mine more lumps of bitcoins, the number of bitcoins per lump will decrease. Eventually, mining will only get you a tiny fraction of a bitcoin. And once all the bitcoins are mined — sometime around 2140 — that’s it. They’ll remain in circulation but you won’t ever be able to mine more.

The value of bitcoins has fluctuated widely since they first hit the digital scene. In February, the value of a bitcoin was around $20. On April 10, the value had climbed to $266 per bitcoin. The next day, the value dropped more than $100 in heavy trading. It has since started to climb up again. But the volatility of bitcoins have led some to describe the whole market as a bubble ready to burst, similar to the dot-com bubble or the real estate bubble.

My biggest problem with bitcoin is that it’s not really being used as a currency for the most part. There are merchants who accept them. Some are legitimate businesses. Others, like the infamous Silk Road, are black markets that deal in illegal goods. But it seems to me that more people treat bitcoin the way you would gold — it’s a commodity to invest in rather than a currency to spend. In my mind, that makes bitcoin a pretty poor currency, though you could make a pretty penny through speculation and some particularly lucky timing.

One argument bitcoin fans make is that since bitcoin isn’t tied to any political system or national government, it’s free from the failings of those institutions. But I’d counter that any currency, whether backed by a state or otherwise, is only valuable if people have confidence in its value. It doesn’t matter if the currency is backed by a state or if it’s backed by an enormous computer like Deep Thought. If people believe in the currency, it will serve. If people lose faith in it, it will fail.

Other factors can cause currencies to fail too. Some are related to politics and some are wrapped up in that crazy voodoo mumbo jumbo that makes up economics. But just because a currency is free from state influence doesn’t mean it’s got a better chance of surviving than an “official” currency.

Will bitcoins ever become a widely-used currency? It will require the volatility to settle down quite a bit. Right now, merchants have to adjust prices on goods frequently because the value of bitcoins changes so suddenly. Imagine selling something for a single bitcoin which, at the time of the sale, is worth $50. The next day, the value of the bitcoin jumps up to $250, giving you a huge profit. Or it drops down to $5, possibly pushing you close to bankruptcy. You can’t maintain an economy with fluctuations in value that are that dramatic.

Maybe we’ll all be using bitcoins in the future. For the time being, I’ll go back to using my own method of paying for stuff using coupons good for one backrub. I’m so hungry.

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