Tuesday, April 2, 2013

Bitcoin Prices Blast Through $100, Driving Speculators Wild

If you're like most people, you've probably been hearing a bit about "Bitcoin" recently.

And, if you're like most people, you'll probably not know what it is or what to think about it--or what the fuss is all about.

Here's a snapshot.

Bitcoin is an electronic currency--a new form of money.

Bitcoins take the form of strings of numbers that can be electronically owned by and transferred among individuals and organizations. For now, the currency is primarily used for payments by fringe retailers or illegal transactions, but it is being accepted at more and more places. And organizations that exchange Bitcoins for standard currency are now being approved to operate as banks.

The premise and promise of Bitcoin--the part that appeals to folks who don't happen to be gold bugs or cryptography geeks--is that the current plan is for only a finite number of Bitcoins to be created. This is in direct contrast to standard government-issued currencies, which governments can always print more of. If the supply of Bitcoins remains finite, this should theoretically eliminate inflation, which is one of the biggest drawbacks of paper money.

(Although inflation has remained low in recent years, it ravages the value of paper money over time. A dollar in 1900 is only worth about $0.04 in today's currency.)

So Bitcoin is conceptually very interesting, especially since it is not issued by a government agency.

What has suddenly grabbed the public's attention about Bitcoin, however, is the recent explosion in the value of the currency.

Because the number of Bitcoins is limited, their value increases rapidly when more people want them. And when the value of something increases rapidly, more people want it because they see it as a means of making money. So the initial price increases fuel future price increases which fuel more future price increases...at least for a while.

This dynamic has fueled the inflation of every asset bubble in history. And they have all ended badly. So it behooves people to analyze the sustainability of such price increases carefully.

When Bitcoin was launched in 2010, the currency initially had very little value. Quickly, however, the price of each "coin" soared above $25, making the initial Bitcoin believers rich. Then prices collapsed, with coins trading down to $5 again, making Bitcoin adherents into fools. Then Bitcoin prices began a slow and steady rise that has suddenly gone parabolic.

At the beginning of last month Bitcoins could be exchanged for about $35.

Now they're changing hands at above $90.

This explosive price increase has many intelligent people crying "bubble!"

And these intelligent people may well be right.

But if there's one lesson that gets repeated again and again in bubbles, it's that prices can rise much higher and bubbles can last much longer than most observers think.

Internet stocks, for example, were first described as a "bubble" in 1995, a full five years before the peak. And the amount of money made in those next five years made everyone who was skeptical early on look and feel like a fool. House prices, meanwhile, were described as a "bubble" as early as 2002 and 2003. And it wasn't until 2007, many years later, that house prices finally peaked.

Driving prices in all bubbles, of course, is the possibility that the price action might not actually be a bubble.

That applies to Bitcoin, too.

If Bitcoins become an accepted currency everywhere in the world, if governments don't make Bitcoin transactions illegal, and if the supply of Bitcoins remains finite (if the systems aren't hacked or the anonymous creators don't get greedy and decide to create many more), then Bitcoin prices could go much, much higher. - Read more here: http://finance.yahoo.com/blogs/daily-ticker/bitcoin-prices-blast-100-driving-speculators-wild-150415225.html

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