Why bitcoin bites

Bitcoin‘s incredible surge past $US1000 ($US1097 at time of writing) has markets agog.  The peer-to-peer crypto-currency is hotter than summer right now.

teh internets

The guy who trades beef for bitcoins will be feeding his heifers Dom Perignon. The guys who accept bitcoins for jocks can buy a small island and never wear anything other than their products.

The frustration of not buying into Bitcoin is palpable (a kid I interviewed for a story for the Financial Review in April bought in at 0.10c), and is matched only by the excitement at the prospect of it rising a similar amount again. But I suspect the trend will go the other way.

Bitcoin has been compared to gold. It has value only so long as we agree it does, it is limited in quantity and you can use it as a medium of exchange.

Bitbugs should be so lucky. Centuries of alchemy has brought us no closer to replicating gold, but bitcoin’s properties are visible, public and replicable.

Anyone can make their own currency. And given the upside, thousands will.

If the elusive Satoshi Nakamoto (inventor of bitcoin) kept just one percent of the globe’s bitcoins for himself, he’d have 120,000 of them, worth $120 million; [the total stock of bitcoins will grow until it reaches 21 million and can be found here.]

The prospect of that sort of cash for free is a powerful motivator and so the field of virtual currencies is suddenly really really crowded.

Do you fancy Litecoin, up 400 per cent this week?

Namecoin, up 64 per cent in the last 24 hours?Peercoinanoncoin?

Rolling with a hunjy One of the charms of traditional currencies like the plain old Aussie dollar is there will generally be fewer of them than there are seats at the United Nations. Not so with crypto-currencies.

There’s around 60 listed on an exchange called cryptsy, and that’s even before the crazy bitcoin price action of the last few weeks, which will no doubt tempt otherwise serious sounding people to wade into the waters. Some of the replacements will offer better features than Bitcoin, which many people fear could be hacked.

In this scenario, the only advantage Bitcoin retains is having been the first.

Bitcoin is unlike Microsoft, which was able to use first mover advantage to generate network effects and lock-in in the market for Windows.

A trailblazing and widely-cited paper on first mover advantage says a first mover advantage only offers opportunities to get an advantage.

“Unless a firm has the expertise, resources and creativity necessary to exploit these opportunities…being first to market will produce neither sustainable competitive advantages nor desired performance outcomes.”

Given bitcoin is a peer-to-peer system, its ability to coordinate expertise, resources and creativity may be very limited.

Investing in Bitcoin is a bet on pure first-mover advantage. That’s the same business strategy of AltaVista (overtaken by Google) hotmail (gazumped by gmail) and Hi-5 (eclipsed by facebook).

Agree? disagree? share your thoughts below.

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

4 thoughts on “Why bitcoin bites”

  1. Is hotmail really guzzumped by gmail? Admittedly I did start a gmail account because hotmail was languishing but the Outlook setup they have now works really well.

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  2. Heh, I was thinking of writing a post about Bitcoin as well! There are so many things wrong with it the mind boggles. I agree with all you said, but what really gets me is that it is currently useless as a currency: the ridiculous rate of growth in its value puts on such deflationary pressure that people are unwilling to spend any of it lest they end up regretting it, like in this story:

    http://motherboard.vice.com/blog/this-pizza-is-worth-750000

    (It’s out of date, btw; the amount of BTC spend on those pizzas now exceeds *$10 milliion* in value.

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  3. Yours is the first posting I’ve read on the competition between between cryptocurrencies and its something to consider. The dismissal of first mover advantage without lock-in is fair, but that’s what competition is about. You cite AltaVista vs Google, but Bing? And no doubt somewhere and some when Facebook’s nemesis lurks (I rather think it will be fragmentation that takes down the large centralised social network, but never kill the mass market core.)

    You claim, “Given bitcoin is a peer-to-peer system, its ability to coordinate expertise, resources and creativity may be very limited.” P2P is largely irrelevant to that conclusion, Bittorrent is P2P and seems to be thriving. More significantly to the expertise, resources and creativity, Bitcoin is open source (source of all the parametric variations like Litecoin et al). Expertise, resources and creativity will choose the best place to invest themselves. You can claim co-ordination is not an open source strength, but it has proven otherwise in many once proprietary and closed network and application examples.

    Many crowd-sourced and emergent examples exist.

    Thanks for the good words on the existence of intra-cryptocurrency competition, that is novel, most seem to drivel on about state backed fiat, or take the inconclusively sage position that Bitcoin may be the first, but not the winning virtual whatever it is. I think you are right to consider the possibility of a wide variety of easily peered value systems that may be parochial, community, or interest focused.

    Bring on the arbitrage!

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