A magazine dedicated to all things Bitcoin
Exploring the Bitcoin Bubble: from February to Nowauthor: Vitalik Buterin
published: 2011-06-10 23:01:05 UTC
There has been growing concern about the rising Bitcoin prices, and the sustainability of these constant increases. Many see the increases as harmful to Bitcoin's future as a currency, stating that the extreme deflation will discourage spending, and many believe that Bitcoin's value will soon collapse. There are now two questions that need to be asked: first, is the increasing valuation of Bitcoin a bubble or is the price rising because there is more and more demand for bitcoins to be used as a currency, and, second, if there is a bubble, to what price will the value of Bitcoin crash?
In the recent history of Bitcoin, we can trace two events: the spike in Bitcoin prices in February, and the beginning of the rapid exponential growth in early April. To determine to what extent this rapid exponential growth is a bubble, we need to understand what the properties of a bubble are, as opposed to the natural growth of a currency. As I have mentioned before, in a natural growth, people buy into the currency because they expect to cash out in the future by buying a different product than the one they cashed in with, thus getting a profit through economic exchange, while in a bubble people buy into the currency because they expect to cash out into the same product that they bought in with, just at a better price - in this case, there is no value created because there is no product passing from the hands of someone that needs it less into the hands of someone that needs it more. The currency in the bubble is valued by its potential to keep increasing in value, and without this potential it is valueless. Thus, in a bubble there cannot be any long-term price stability. The slow, steady 2-month reduction in price between February and April thus does not resemble a bubble, and it can be safely said that 0.5-1 USD is a value influenced more by the fair valuation of Bitcoin as a currency than by speculators.
Now, let us examine what happened in April:
Here is a logarithmic graph of four things: Google search volume for Bitcoin (representing publicity), Bitcoin price, the number of new posts on the Bitcoin forum (representing activity within the community) and the number of MtGox trades per day. I have placed the raw data here; it is collected from Google Trends, the Bitcoin Markets API and the Bitcoin Forum Statistics Center. We can see that all four remained roughly constant before April, but then all suddenly began increasing. The number of trades jumped up suddenly, but this does not mean that Bitcoin has been taken over by speculators; rather, it is a necessary consequence of the fact that the Bitcoin community began increasing in size, and new Bitcoin users need to buy coins while established users do not. Up until April 27, the size of the forum, the price and the search volume continued to grow in lockstep, suggesting that the increase in prices up until this point was also the result of more goods and services being exchanged for coins. Over the next few weeks, however, some changes occurred: first the Bitcoin price increased relative to the search volume and the size of the forum, then the search volume spiked up, increasing faster than the forum, then the Bitcoin price corrected downward, and now it is rising again. As of June 9, the Bitcoin price shot up even further up, and came back down.
What does this analysis means for Bitcoin's future though? In the short term, we will see further bubbles and corrections. In the medium to long term, however, these are minor blips, and the signs are positive. The previous correction in the middle of May only brought the price down to a medium-term trend line, at which there seems to be considerable stability. The short-term data show that the ratio of speculation to interest has jumped up, but in general bitcoin price is clearly proportional to its popularity, both in terms of Google search volume and activity on the Bitcoin forum itself. The data shows that Bitcoin's value growth is motivated not by shadowy institutional investment but by genuine public interest in Bitcoin not only as a commodity but also as a community. The Bitcoin economy is still increasing in size; more and more goods and services are offered on the forum and there are more and more services available; the newest direction of growth is freelance sites like workforbitcoin.com and ForBitcoin, and auction sites like BitcoinHop, BTCBids and BiddingPond. Much of the Bitcoin economy is sometimes criticized for being 'gimmicky' but these are legitimate applications where Bitcoin shines; as I discussed here, it can be difficult for a casual user to set himself up to receive money through internet transactions, and Bitcoin goes a long way toward remedying this.
The articles that the media releases about bitcoin do not focus on its value as an investment, linking new Bitcoiners directly to Liberty Reserve and MtGox, they focus on its value as a currency. Conside, for example, the most recent: Bitcoin is an "online currency taking off" but the article does not even talk about its rise in value; it praises the currency's decentralization and just mentions that "currently a Bitcoin (BTC) is trading at around $15." We can look to the chart to see the difference: an article in Forbes, a business magazine, predictably caused a mini-bubble, but the most recent articles are aimed not at investors, but at the technology media and at the general public, and these types of articles result in more sustained growth. The different indicators of Bitcoin's popularity are increasing roughly in sync with each other, suggesting some degree of stability. This is the difference between the Bitcoin bubble and conventional speculative bubbles: when the speculators cash out the price may suffer a severe correction, but there will not be a reduction to near zero, since the public is being drawn in not by the promise of making money off the upward slope of the Bitcoin price, but by the possibility of using Bitcoin as a currency, and this use is increasing just as exponentially as the price. The idea that the price will crash to near zero is motivated by the concept of a conventional bubble: without growth, the bubbling commodity has no value. Bitcoin is different; in fact, if we want to see what will happen to Bitcoin's price if the exponential growth of its popularity levels off, we can always look back to the last time it happened for guidance: there was no crash, the price simply stabilized onto a slow downward slope.
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