Anniversary of the Great Bubble of 2011
On June 8 exactly one year ago, the price of a bitcoin, having risen over the preceding two months from sub-dollar prices and public obscurity, briefly hit its all-time high of $31.91 before crashing down to $10.25 and beginning a slow and steady decline that would decrease its value by over 93% over the next four months. The sudden climb brought great hope to the Bitcoin community, with some expecting that its value would hit $1000 and it would enter mainstream usage by the end of the year, and the decline brought no less despair, as mainstream media turned against Bitcoin, pointing out first the existence of black market applications like Silk Road and later questioning its economic model. By late November Wired even wrote an article proclaiming the “Rise and Fall of Bitcoin“, setting the stage for many outside the Bitcoin community to see the currency as a failed experiment and even an example to point to when defending the need for centralized control.
However, Bitcoin overcame all of this, and just one month after proclaiming the currency’s fall Wired took back its words with an article proclaiming its comeback, and the price of the currency proceeded to rise once more before finally stabilizing at $5. While the decline following the bubble did have some negative effects on the public perception of Bitcoin, as the opinions of some turned so sharply against it as the price slowly collapsed, there is a strong case to make that the effects of the bubble have largely been positive. The Bitcoin community acquired most of its current members around this time, and judging by the fact that the community still exists it is evident that many of these new entrants are willing to endure hard times for the sake of a brighter long-term future. The opinions of some may quickly change with the tides, but there are some who see that Bitcoin has a long term fundamental value that will make it a useful good to hold no matter what price it may be worth on the market and have invested hundreds of thousands of dollars into both the currency itself and the businesses that support it.
Now, at a time when Bitcoin has been more stable for the past four months than even mainstream commodities like silver and the mood might just be turning toward another rally, many are looking back to what happened in the spring and summer of 2011 and are expecting another bubble of proportionate size. One the one hand, such skepticism to Bitcoin’s present stability is a very reasonable response, and it is vitally important that we as a community do not take for granted factors which may change at any time. However, there are several reasons why such an event is not likely to repeat itself at this time.
First, there have been no changes in fundamentals. The bubble of 2011 accompanied a fundamental shift in the prospects of Bitcoin economy: that of mainstream attention. Bitcoin was mentioned on Forbes and Time magazine, potentially putting it in the hands of Wall Street billionaires, and the number of people who were aware of Bitcoin in the tech community skyrocketed. Now, however, there has been no such shift. There has been more and more evidence of growing Bitcoin adoption behind the scenes, and Bitcoin businesses like Coinabul, BitPay and BitInstant have all been reporting massive rates of growth over the past six months and new products have been released, but news of this sort has been circulating for months. A change in fundamentals comparable to that seen in April and May last year would be the adoption of Bitcoin by a mainstream business, not hints of shadowy movements in China.
Second, the Bitcoin economy is more decentralized, and therefore more resilient to any sudden changes in expectations, both positive and negative. The Bitcoin economy of 2011 was heavily dependent on centralized providers in all sectors, relying heavily on Dwolla, MyBitcoin, Deepbit, adoption specifically in the United States and, most importantly of all, MtGox. A collapse of the latter could have easily brought the Bitcoin economy to its knees. Now, however, there is a much greater degree of resiliency on all sides. The most recent major news in the Bitcoin economy was the shutdown of Bitcoinica, its only margin trading provider and the second largest Bitcion trading site surpassed only by MtGox itself, but its collapse only reduced the Bitcoin price temporarily by less than 5%, a decline which was quickly corrected and even reversed. The only exception seems to be the Bitcoin lending market, dominated heavily by Pirate and the GLBSE, and a collapse of particularly the former will mean losses of hundreds of thousands of dollars, but even this will not have as much of an effect; the activities of Pirate are largely confined to the Lending and Securities subforums at Bitcointalk, and many casual Bitcoin users and almost all observers have never even heard of these activities. Because there are far more businesses that can now succeed and fail in the Bitcoin economy, the effect of each one is lessened.
Third, the possibility of shorting will provide a dampening effect on any bubbles. Right now, since Bitcoinica has shut down there are no margin trading platforms available, but Kronos.io will soon enter the stage and once again fill this niche. The problem during the 2011 bubble was that there was no way of taking a position against the rise of Bitcoin prices, so while many were skeptical that the bubble would last there was nothing they could do about it. What short selling (or “shorting”) does is allow people to effectively own a negative quantity of bitcoins, redirecting investors who would otherwise be purchasing bitcoins on the open market and pushing prices up further to buying a virtual bitcoin whose value the short-seller is accountable for. If enough people to this, shorting absorbs upward market swings and helps stabilize the market.
Finally, cultural memory matters. When the Bitcoin community encountered the bubble of 2011, it had not seen anything like it before. The only similar rises in prices that preceded it were the ones from $0.05 to $0.30 and then from $0.30 to $1.10, both of which were followed by either temporary stagnation or only relatively slow declines in price. Now, however, there is a much greater awareness of the dangers of both overexcitement and despair, and a general understanding that price stability is important is much more prevalent. History never repeats itself exactly the same way twice, and Bitcoin is no different.
If a mainstream business does suddenly decide that it would begin immediately using Bitcoin and promoting it to millions of customers, then these factors will indeed change. The economy would at least temporarily recentralize, cultural memory will once again become a void as the community loses all precedent, and no one will be willing to short when prices are going up so high that betting on the end of a bubble too early would simply result in forced liquidation as too much money is lost in the short term. If there is a fundamental shift that would force Bitcoin to grow by a factor of ten in a single year, then it is quite likely that the straight line growth of 25% per month would eventually turn itself into a faster climb followed by a slump. For now, however, greater stability is still the norm.