Financial Cryptography

A Bitcoin for your thoughts... (may regulators live in interesting times)

Bitcoin has surged in price in the post-Cyprus debacle. To put the finger on the issue, the Troika recommended that the bank deposit holders be hit, and thus the people should directly participate in the pain of bank reconstruction. This is the right solution and the wrong solution, as I pointed out at the time.

Now we see why it is wrong. The faith of the people in banks is undermined, and rightly so. The "only this time" solution of haircutting the depositors is nonsense, and the people know it. (For those who don't follow this sort of arcania, the FDIC has already rolled out the plan for hitting the depositors in USA, and the other countries are following suit.)

Then, ordinary people putting faith elsewhere is a growing momentum. With the recent surge of post-Cyprus purchases of Bitcoin, it would seem that more and more people are piling in. I counted 3 independent pings in the last 2 days: journos, geeks and my mother.

This tells me that ordinary people are getting involved in Bitcoin. The old adage about bubbles is that you should get out when the delivery boy gives you a stock tip when riding up in the lift (elevator). And bubble is what we are seeing, as Bitcoin price is purely driven by supply and demand, and right now the surge in demand is outstripping the supply.

But let's take a step back and ponder where we are going. The big picture. A year ago I write with Philipp Güring about the effect of Gresham's Law and criminal elements on Bitcoin, and opined that this would limit the Bitcoin unit in the long term. Gresham's Law is simply that, a law, and is mostly fixed by the mining algorithm (which will end) and the block-agreement algorithm (which continues).

However, the criminal effect is an artifact of people and is an effect that is reversible.

If the mass of people get into it, then this can swamp the bad elements and reverse the effect of the disease. And, this isn't abnormal, in fact it is the normal new market growth process: early adopters are replaced by the mass market. (People familiar with the VHS story will see rhymes here.) If mass adoption reduces the nasty element to the point where it is below some threshold of cancer, then the unit can and should survive.

Right now, it feels like that - everyone is positive about Bitcoin. We can predict that the emotion will feel the reverse rapidly when the current bubble bursts and the stories of loss circulate. But maybe Bitcoin will survive that too, this is its second bubble, and may not be its last.

Which leads us to consider the regulatory angle. I would say the regulators have a problem. A big problem! If we analogise the Bitcoin market along the lines of say MP3 music, back in 1997, we could be at the cusp of a revolution which is going to undermine the CBs in a big way. Bitcoin could survive, be mostly illegal in the eyes of the regulator, and mostly acceptable in the eyes of the people.

It's game on. The regulators are starting it issue new regs, new guidance notes, etc. But that isn't going to do it, and may even backfire, because while the regulators are looking to attack Bitcoin at front, they are still working to undermine the credibility of banks from behind. A credible message is lacking.

And the timing couldn't be better, as the European crisis gathers steam. Spain, which is where the Bitcoin surge started, post-Cyprus, and Italy are likely both in for another bailout. Slovenia was in the news this week. No analyst I've read believes that Europe can survive more than one big bailout, nor the USA can survive Europe.

Which leads to that old Chinese curse -- may you regulators live in interesting times. This would be a fantastic time to be there, debating and crafting solutions and new world orders. Good luck, but a word of advice: your challenge is to find a credible message -- from the point of view of the people.

Posted by iang at April 12, 2013 02:47 AM | TrackBack