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Bitcoin Free Fall

Timothy Lee looks at the declining value of Bitcoin, the peer-to-peer digital currency which has been tumbling down for the last week or so, writing:

Most assets have a “fundamental” value: the value that reflects the practical use to which that asset can be put. You can always live in a house regardless of what happens to the real estate market, so we can be confident that house prices won’t fall to zero. Similarly, if the price of gold fell too much, people could always use it to make jewelry, so gold is a relatively safe investment.

The puzzling thing about Bitcoin, which I pointed out back in April, is that the currency doesn’t seem to have any fundamental value at all. True, you can currently purchase a limited selection of goods and services with Bitcoins. But the volume of Bitcoin-denominated commerce is small enough that Bitcoin-denominated prices seem to be driven by the current value of Bitcoin rather than the other way around.

This is different from traditional currencies. The fact that there are 300 million Americans who use dollars for their day-to-day transactions creates a floor for the value of dollars. Most of us don’t pay much attention to the exchange rate between dollars and other currencies, because we’re used to thinking of dollars as our fundamental unit of value. And even if we wanted to stop using dollars, it would be hard to do since most of the people around us won’t take anything else. So, barring a major screw-up by the Federal Reserve, we can count on the value of dollars not falling very much.

In contrast, there’s no significant community of people who conduct commerce exclusively (or even primarily) in Bitcions. And you can’t eat, live in, or make jewelry out of Bitcions. And this means there’s no logical stopping point to Bitcoin’s price decline. So far Bitcoin enthusiasts have been buying Bitcoins as the price falls, convinced that the price will go back up eventually. But as the hoped-for rally has failed to materialize, more have gotten discouraged or bored and cash out, pushing the price down further. This process has been going on for a couple of months, and now it appears to be accelerating. I suspect it’s terminal.

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