The bitcoin bubble: spike, crash, what’s next?


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The buzz about bitcoin has become a roar over the past year as the digital currency has undergone a wild spike, fall, and subsequent rise in valuation. Its fluctuation from $11 per bitcoin (BTC) at the start of November 2012 to well over $1,000 per BTC in late November 2013 has made it fodder for the endless news cycle and fuel for dreams of easy riches. Along the way, bitcoin has attracted waves of new enthusiasts, entrepreneurs, promoters and speculators, all of them wondering, “Is it just a bubble?”
In the beginning, that’s 2008, a person or persons unknown, using the name Satoshi Nakamoto, floated the noble idea of a digital international currency that would be free of control by central banks and free of manipulation by national treasuries. All transactions would be open and tracked in a digital register, though the people or companies making them would enjoy cryptographically protected anonymity. A finite amount of the currency would be created over time — digitally “mined” through a process of mathematical computation that anyone could engage in — eliminating the threat of inflation.
Perhaps best of all, at a time when banks and governments had proven themselves untrustworthy, the currency could be traded peer-to-peer, cutting out all middlemen and crossing all borders. Like the internet itself, it would be global, decentralized and democratic.
WILD GYRATIONS IN VALUE
The idea came to life in August of 2008, when a domain called bitcoin.org was registered anonymously and the bitcoin computer protocols put in place. The first block of 50 bitcoins were “mined” on January 3, 2009 and the first exchange value — published in October and based on the cost of the electricity required to run a computer and mine one BTC — was 1,309.03 BTC to one dollar.
On November 6, 2010, BTC briefly touched $0.50 per BTC at Mt. Gox, the world’s first bitcoin exchange, on trades of 32,756 BTC. On November 30, 2013, a bitcoin was trading in the vicinity of $1,159, while most of the high-minded reasons expressed at the time of the currency’s creation were beginning to appear to be wishful thinking.
As bitcoin approaches its fifth anniversary, it is clearly in a transitional stage. The wild gyrations in value that have earned bitcoin so much attention have also made it appear to be less a currency than a speculative platform. Today, the majority of daily bitcoin transactions are made at virtual casinos, for gambles on dice and poker, or at the many bitcoin exchanges where the digital currency can be bought or sold for “real” money.
Though bitcoin currently remains free of the influence of central banks and national treasuries, it is not immune to manipulation. Early adherents and speculators in bitcoin have amassed enormous concentrations of bitcoin wealth. The Winkelvoss twins, for example, famous for their battle with Facebook, announced in April 2013 that they owned one percent of all bitcoin in circulation. A Maltese hedge fund named Exante claimed, at about the same time, to have cornered another one percent in its Bitcoin Fund and boasts of a 1,000-percent return over three months.
Such bitcoin holders, along with the many companies that have sprung up to create an infrastructure for bitcoin trading and transactions, have a vested interest in maintaining the buzz that feeds the frenzy. They also, theoretically, have the means to manipulate the market in a significant fashion. Consider this: in the 24 hours of November 7, 2013, the bitcoin market price at the major exchanges — as tracked at www.blockchain.info — went from $257 to $297, an increase of about 16 percent, on only $22 million in trades. On November 11, market value increased 11 percent, rising from $339 to $375, on only $7.5 million in trades.
WOOING THE MAINSTREAM
Maintaining the buzz about bitcoin requires that it be perceived as closing in on mainstream acceptance, both in real world usage as a currency and as a legitimate investment vehicle. To that end, press releases fly, hyping every development to the tech and financial press, much of which takes these self-interested alerts at face value.
When Baidu, commonly referred to as China’s Google, announced on October 15, 2013 that it would accept bitcoin payments for security services from one of its divisions, it was hailed as groundbreaking news. Here was more proof that bitcoin had real value and that major players were prepared to accept it. While the news certainly had an effect on market value and real impact on Chinese interest and investment, the actuality has been almost totally symbolic. In the month since Baidu started accepting bitcoin, only 35 transactions have been made, with a total value of $515. Chump change, indeed.
The real story here is that Baidu accepts bitcoin only for its recently acquired Jiasule division and, ironically, is using the allure of bitcoin to boost its own image as an innovative service.
The Baidu statement begins, in translation, “How can we reflect the characteristics of a trendy IT person and a professional webmaster? The answer, of course, is to own bitcoins!!!” It goes on to say, “Baidu Jiasule, as the innovator of the Internet, has become the first cloud services vendor to support bitcoin, giving us richer payment methods and experience.”
Still, efforts to build a legitimate investment environment and to create a vigorous infrastructure for bitcoin as a vehicle for international monetary transfers are being seriously and creatively undertaken. Many of the larger players are focusing on selling bitcoin as a way to avoid the high transfer fees charged by credit card and wire companies. They point to the more than $500 billion annually remitted to third world nations — and the $4.6 billion in transfer fees reaped by Western Union alone — as an opportunity for bitcoin to do good and prosper at the same time. The companies that can simplify the bitcoin transfer process enough for even computer-klutzes to use and find a way to safely lock in time-of-transfer values stand to become long-term and viable businesses, even after the bitcoin bubble bursts.
In September, SecondMarket Inc., the registered broker-dealer known for facilitating trades in private companies such as Facebook Inc., announced the creation of the Bitcoin Investment Trust (BIT). The first U.S. fund to invest solely in bitcoin was hailed as a step toward solidifying the bitcoin image. It would allow institutions and qualified investors (people earning over $200,000 annually or with a net worth of over $1 million) to get into bitcoin without the hassle of buying, storing and providing security for the digital currency. The Trust even makes it possible to include bitcoin as part of a self-directed IRA. How much more mainstream can you get than that?
It is instructive, then, to consider the Bitcoin Investment Trust’s advisory to potential investors regarding risk factors. These risks include:
• Market adoption. BIT points out that bitcoin may never be broadly taken up as part of the world’s financial system, “in which case, bitcoin may lose most, if not all, of it value.”
• Government regulation. As bitcoin has become more visible, it has begun to attract attention by governments in regard to regulation and taxation. BIT notes that “future restrictions by state and federal authorities may have a significant impact on the value of bitcoin.” This may be nowhere more significant than in China, now a major bitcoin venue, whose autocratic government has shown itself to be highly protective of its currency.
• Security. As its value increases, bitcoin becomes more attractive to hackers and fraudsters. On November 12, a Chinese bitcoin exchange shut its website down and disappeared, along with $5 million in other people’s bitcoin. BIT warns that “bitcoin that
are lost or stolen cannot be replaced, as transactions are irrevocable.”
• Tax treatment. Due to a lack of clarity regarding bitcoin as an investment, “the tax consequences to a BIT investor could differ from the investor’s expectations.”
So, there is some caveat emptor to keep in mind while you read about the latest spike or crash in bitcoin value.

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