Why you don’t understand Bitcoin and yet are fascinated by it

Posted on April 4, 2013

2


Not much time today, but wanted to put down some thoughts on why Bitcoin is so hard to explain/understand – and hence why it’s so fascinating.

There’s been a lot of talk recently on major financial streams about Bitcoin, and generally about why it’s either in a bubble, or why it’s not a good idea. Reading through some of it, it’s clear that 1) there are some very smart people weighing in, and also 2) smart people are also very specialist. The kicker is that Bitcoin straddles specialisms beautifully. It’s a mix of strong crypto, (technical) network effects, financial theory and crowd behaviour. That’s why you don’t understand it. Bitcoin is a mutant.

Here’s some quick thoughts that might help though:

1. Bitcoin is an experiment

That’s the first thing to remember. Nobody really knows what’s going to happen.

But at the same time, nobody really knows what’s going to happen with any other currency either. Remember that time we settled on the one-size-fits-all sustainable global monetary policy? Me neither.

That means that Bitcoin will have accidents and will get attacked – successfully, in all probability. But how much that damages the effort as a whole depends on a whole lot of other things.

2. Value is a complicated formula

In fact, I think of it as something like:

Bitcoin Value
=
[Usefulness of API + Trust in crypto + Usefulness of "anonymity" + Usefulness of global network
- Stability of "traditional" money]
x
News coverage (or “Hype”)
x
Optimism
x
Naivete of buyers

In other words, a whole bunch of stuff which comes and goes depending on external factors all the time. If someone invents an awesome new service, value goes up. If rich people’s bank accounts stop being raided, value goes down. If the underlying crypto or TCP network is threatened, price drops. “Naivete of buyers” covers greedy speculation as an amplified, and is where we’re currently seeing huge changes.

3. Bitcoin is overvalued short-term, and undervalued long-term

Are we in a bubble? Yes and no.

Right now, news coverage and rich speculators are playing chaos with Bitcoin (again) – but it’s an inevitable chaos which is inflating the underlying “real” value. The timing is perfect – there are several factors which mean Bitcoin is undervalued in terms of “functional” value, and at the same time overvalued for “actual” value (ie. market price):

a. Decentralised networks are IN. People keep comparing Bitcoin to Napster, which is pointless. They should be comparing it to email and bittorrent. Think about that, and about which ones are still going.

b. Global recession is IN. Nobody really knows where “value” is coming from now that we’re out of the Internet, Housing and the Credit bubbles. This all adds to the hype/speculation multiplier for market value.

c. National currency seizure is IN. Apparently seizing private assets is unpopular with individuals, and apparently crypto is good at hiding stuff. Go figure.

Right now, we’re at a point where interest is outstripping technical development. That’s really really important to understand, in terms of value – most of the hype is based on what Bitcoin could or couldn’t do. That’s the short-term bubble – based on untested ideas and people’s daydreams.

In the long term, if Bitcoin can seize its potential (and that’s more likely as it gains in interest/value, ironically) then its “usefulness” value will carry on increasing.

So whenever you hear talk of the “Bitcoin Bubble”, it’s important to put that into context. Are you talking about a 24-hour bubble, a month bubble, or a 25 year bubble? And where will other money systems be after that time too?

 

I have an admission – right now, Bitcoin is exciting, but not interesting to me. That’s because I’m a developer, not an economist. The exciting stuff for me is the technical (and thus social) infrastructure that a money-based-on-code offers. There all sorts of great ideas for playing with Bitcoin that are being hampered by volatile price swings at the moment.

While those are happening, it’s easier to see Bitcoin as a commodity, instead of an algorithm. Which is annoying. Because right now, algorithms are what will change the world.

 

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