The Real Significance of the Bitcoin Boom (and Bust) The volatile rise and fall of Bitcoins has prompted lots of stories explaining why the online virtual currency is a classic bubble. Many compare it with Tulipmania in 17th Century Holland, where the prices of rare tulip bulbs soared to absurd heights and then crashed, ruining the speculative investors who had bought them. But the Bitcoin phenomenon is more than a bubble. It says something important about the current and future state of the global economy. The scale of the recent boom and bust has been staggering indeed. At the start of the year, a Bitcoin was worth $13.51. Earlier this week, it traded as high as $266. And on Thursday, it plummeted to less than $100, as one of the exchanges where Bitcoins are traded closed temporarily. This would be comparable to the exchange rate for the British pound soaring from $1.62 (where it was on Jan. 1) to $31.90 and then falling back to $12. Such monumental appreciation and volatility is clearly the result of speculation – people buying the online currency just because they think its value will rise, not because they want to use it to purchase goods and services. But Bitcoins’ gains are not the result of speculation alone. They partly reflect the fact that the Bitcoin system is much better designed than previous online currencies. And more significantly, the runup also reflects anxiety about the safety of the global banking system and the stability of major international currencies. (MORE: No Money, No Problems: Canada Considers Completely Digital Currency) The technicalities of the Bitcoin system are complex, but to make this online currency more successful than previous versions, the designers overcame two key challenges. First, to prevent counterfeiting, they attached a history of transactions to each currency unit – but allowed users to keep their transactions nearly anonymous. Counterfeiting is hard because fake Bitcoins would need an authenticated history to pass muster. Second, they strictly controlled the supply of Bitcoins outstanding — thereby saving it from the disastrous fate of, for example, the paper currency known as assignats
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