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The Dark Side of Bitcoin

2011-10-19

I have previously written about how Bitcoin is a great alternative currency but since the value has dropped to 2.5 US Dollars per BTC I guess it's about time to talk about the problems which Bitcoin does have. But do note that I still stand by the fact that Bitcoin can work just as well as any other currency, or even better, because there is nothing wrong with the currency itself compared to others.

An Almost Exclusively Speculative Market 

The most important thing to realize is that while the US Dollar represents a market dominated by actual services and real products the market represented by Bitcoin is almost entirely speculative. Because of this, there is no such thing as the value of a BTC, there is only the speculative value.

Until the Bitcoin market starts selling products and services to a much greater extent, the value of the Bitcoins will remain entirely speculative. But it's important to note how extremely difficult it is for a new currency to gain widespread adoption. There's a bit of a chicken and egg problem; retailers don't want to use Bitcoin because the consumers don't use it, and the consumers don't want to use it because the retailers don't use it.

The massive volatility of the currency because of a speculation dominated market certainly makes it difficult for people to use it for trade. But Bitcoin may very well gain widespread adoption in the future, no question about it, but until we hit a critical mass, it will continue progressing very slowly.

Perceived Drop in Value 

A lot of people think that since the value of a BTC has gone down to 2.5 US Dollars from it's peak of 30, the currency is doomed. What you have to take into consideration is that last year it traded for only a quarter, which means that if you look long term, it's really gone up.

What's more important though, is that the numerical value of each unit of currency is not that relevant. The Chinese Yuan is only worth 0.15 US Dollars but China is doing great. The value of a currency going up or down does matter but the way I see it, Bitcoin does not yet actually have a certain value. It is still much too soon to tell how much Bitcoins will end up being worth compared to other currencies.

Distribution Phase 

While the Bitcoin currency is deflationary you can very well argue that there's actually massive inflation right now since it's still undergoing its distribution phase. Bitcoin has an upper limit on how much money can exist but all of that money has not yet been created and distributed.

Every 10 minutes 50 new BTC are created and that will continue for an other year or so, when it'll drop to 25. It will then continue dropping until around 2030 when all Bitcoins will have been created. As such, the Bitcoin economy is currently experiencing massive, but controlled, inflation and it would be extremely surprising if any economy was able to grow fast enough to keep up.

It is therefor only natural that the value of a BTC goes down, after having experienced a large hype wave, as the money supply continues to grows substantially. As more substantial economic activity increases and the increase of money supply starts to slow down, Bitcoins will become more valuable again.