Bitcoin boom – is it already over?

Bitcoin enjoyed a flurry of attention during the recent bailout crisis in Cyprus, with claims the “crypto-currency” would not only give people constant access to their savings – but deliver a potentially “parabolic move to the upside” for investors.

That phrase, from bitcoin entrepreneur Jeff Berwick, could not better describe events of the last two days with bitcoin undergoing a “flash crash”. The currency is certainly “parabolic” with its wild fluctuations more reminiscent of Monopoly than the Footsie.

Each coin has been worth less than $10 for most of the currency’s history, but this week the value surged past $250 before crashing to $105 on Wednesday. Today it has crept back up to $120, according to the most established bitcoin exchange Mt.Gox, which has now suspended trading to allow the market to “cool down”.

No-one knows what caused the crash but I do expect volatility. Jeff Berwick

A statement on its website said: “The rather astonishing amount of new account opened in the last few days added to the existing one plus the number of trade made a huge impact on the overall system that started to lag”.

Mt.Gox claims there are around 20,000 new bitcoin accounts being opened every day with 75,000 new accounts in the first few days of April compared to 60,000 in the whole of March.

Jeff Berwick, from The Dollar Vigilante, calls himself a “financial freedom fighter”.

Speaking to Channel 4 News, he said: “To me it [the crash] is not really a major deal.

“It’s going to be volatile because it’s a very small market. There are only 11 million bitcoins in circulation and it’s been getting so much interest that demand has been overwhelming supply.

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“No-one knows what caused the crash but I do expect volatility.

“I don’t encourage people to invest in them – I just use them as a transaction method.”

He added: “The more people that use it the better – but it’s only three years old. If they start being used as a regular medium they could go to 100,000 dollars each.”

Bitcoin supply

Quick rises in value are also linked to what some economists say is the biggest problem with the currency: the supply of bitcoins increases only slowly, at a rate that is coded into the system.

That is a contrast to a regular paper currency like the dollar, whose supply is managed by a central bank like the US Federal Reserve.

The Fed engineers the dollar supply to increase slightly faster than the growth of the economy, which means that the value of the dollar falls slightly every year.

New bitcoins are “mined” or generated by computers. They get harder to generate all the time, which means the inflow of fresh bitcoins keeps falling. There are about 8 million bitcoins in circulation now, and the maximum that can be generated is 21 million. By 2032, 99 per cent of those will have been created.

Since the supply of bitcoins grows so slowly, any increase in demand leads to higher prices. That is widely seen as a disaster when it happens to a real-world currency. As money becomes more valuable, our incentive is to hold onto the money instead of spending it – slowing down the economy.

The boom-bust cycle has already happened once before for bitcoin. It hit nearly $31 in June 2011 then crashed, hitting $2 five months later.