Sunday, 17 November 2013

Tulip bulbs and Bitcoins

Financial boom bust cycles are interesting stuff (for those not entrapped in them), there is always speculation over what the next one will be and when it will pop. They seem to have a lot in common with Ponzi schemes, but of course everyone denies that till its 'hindsight'.

I was browsing over at zerohedge and came across this article which discusses the value of Bitcoin going over the US$500 mark.

The article discusses the merits of this new 'financial instrument' and how its going to be going up financially speaking. They mention some interesting points including that the Chinese can now buy real estate with Bitcoin (see this reference).

Naturally there is all manner of weird-arsed comparisons between Bitcoin and gold (the metal) and justifications on how Bitcoin is undervalued compared to gold. Bitcoin proponents suggest that its a solid reliable private currency, and its got a great future.

Well what has all this got to do with Tulips?

Well Tulips have come to represent a major financial "bubble". Some time in the 1630's tulip prices went off the scale, it is reported on Wikipedia is this "By 1635, a sale of 40 bulbs for 100,000 florins was recorded. By way of comparison a skilled laborer might earn 150 florins a year".The crash for tulips came when sellers found that buyers weren't paying their desired prices (and it has been suggested that a change in the laws regarding tulip futures contracts had some effect).

It could be argued that Bitcoin is taking off as the international and electronic private currency. But unlike many other private currencies, bitcoin is not underwritten with anything. In a historical study of "unregulated banking systems in nine different countries during the nineteenth century: Australia, Canada, Colombia, China, France, Ireland, Scotland, Switzerland, and the United States" things went well for private currencies. But a significant point in that historical examination of private currencies (see this reference) was that:
A competitive market compels unregulated banks to fix the value of their deposit and note liabilities in terms of the economy’s basic money, by offering redeemability at par (full face value) in basic money. In the past, the basic money was gold or silver coins.
So it seems that people could trust these private currencies because they were backed by the financial institution and redeemable.My understanding is that bitcoin is not underwritten by anything or redeemable for anything except good and or services and trades on the free market. Its value is very much set by the market view of its worth.

Bitcoin is viewed as safe and the technology of it prevents fraud. Sounds good...

So my comparison between Bitcoin and Tulips starts with this post that BitCoin is Broken by a pair of IT academics who have identifed flaws in the security of Bitcoin. They outline a method where:
a minority group of miners can obtain revenues in excess of their fair share, and grow in number until they reach a majority. When this point is reached, the Bitcoin value-proposition collapses: the currency comes under the control of a single entity; it is no longer decentralized; the controlling entity can determine who participates in mining and which transactions are committed, and can even roll back transactions at will.
Nice... of course mining bitcoins takes some serious computing investment (much as does commercial large scale mining in the ground), which is commonly in the realm of BIG governments (you know, like the Chinese or the USA or say a conglomerate of EU nations).

So is this a new Ponzi Scheme? After all Bitcoin is only worth what the market thinks its worth. If the market felt that a Government was in such a control position the market may just flee the system.

I reckon that there is money to be made in buying and selling Bitcoin (just as there is with FX trading) if you have the stomach for it, but ... don't get caught out with the digital equivalent of the Zimbabwe Dollar.

cos in my view, when the music stops you will want to have already sold you seat to someone else. Who knows how far Bitcoin will go up ... I'm no financial adviser, but here is some music to listen to while planning your Bitcoin investment

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