I’m not an economist, but Bitcoin seems pretty scary to me right now. It seems attractive as a decentralized currency, but there are a few properties that are worrisome.
The value (exchange rate) has increased in the past few months past the point of “convenience money” for most. At an exchange rate of somewhere between $10 and $30, there are a large number of people who will buy some without fear that they’ll lose their money, and more importantly, at that level, you have a large number of buyers who bought in early enough to sell at slightly higher rates and still make a comfortable profit. Buying at $30 and selling at $170 (where we are now) is not a bad run by any measure. People are buying in now, but there’s a limited number of bitcoins in circulation and mining can’t keep up with the demand, so people must be selling. Who’s selling? - it’s the people who bought in earlier and are now taking profit on their earlier purchases. Flash forward a bit and imagine that the exchange rate has reached $500. If you want to buy then, you’ll be doing so from someone who bought in earlier and is looking to make a profit. That would be the people who are selling now plus the people who are buying in now. Now flip it around and say you want to sell at $500. Who’s buying? At that point, maybe the media frenzy has died down, or maybe there’s a fresh influx of people who think it’s going to go to $5000. Maybe it will. With no central clearinghouse, there’s no guarantee of being able to sell at any given price, and it doesn’t seem to me like this scenario is set up for long term success. At somewhere in this range and above, you’re talking real money for a lot of people, and the casual speculators will disappear.
Now, let’s look at the transaction rate. MtGox is the largest exchange, by an order of magnitude. As of the time of this writing, over the past 30 days, they have done 2172994 transactions, which is about .83 transactions per second. For a global currency whose market cap is measured at over a billion dollars, this is an astonishingly low number of transactions. (Let’s put that in perspective a bit - so far just today, Google stock was traded 1,990,139 times. Google’s stock price is determined by roughly 30 times as many transactions as all of Bitcoin’s.) Demand is high for now, but liquidity is low, and when it comes time for a lot of people to want to extract some value, there simply aren’t going to be a lot of interested buyers. Most of the previous buyers will have gotten in at near or above the current trading price and so will be waiting for it to continue to rise, a high enough entry price will chase away new buyers who can’t afford to lose their investment, and any dips will keep away the marginally interested people who were only showing up because of the media attention.
I expect the exchange rate to continue to rise for a while, but there’s really no way to know how high it will go, and I think eventually the trap will close on everyone all at once.
I’d love to hear arguments why I’m wrong about this, but I think the time to buy in has already passed.