Why Bitcoin’s Price Is Skyrocketing

Bitcoin hasn’t stopped surging, but that’s only increased calls that the bubble is going to burst. Could this thing pop at any moment? Possibly. Does that mean the price will stop going up? Maybe not. To be clear, anyone who claims to know the direction of bitcoin tomorrow should be taken with a grain of salt. What we can do, however, is investigate the source of all the craziness right now.

Mainstream media attention

By now, every major media outlet has taken a swing at bitcoin mania, with the Financial Times most recently at bat, shouting of falling skies on today’s front page. Some of the reporting is balanced, like Maria Bustillos’ account of the “Bitcoin Boom” over at the New Yorker. Other accounts are downright condescending, the worst of the bunch being Heidi Moore of the Guardian, who labels bitcoin “an obscure digital currency – used mostly for running drugs and laundering money for dictators” that is “too complicated to buy and maintain for people who aren't online 18 hours a day.” Moore’s final conclusion? Bitcoin is the “Harlem Shake of currency.”

Moore’s hyperbole and misinformed generalizations aside, it’s clear that bitcoin remains a polarizing proposition. But controversy is also great for attracting attention. Most Web-savvy folks have at least heard of bitcoin at this point, even if they don’t necessarily have an opinion or full understanding of it. And more attention translates into more interest and more demand.

At last check, the queue for getting verified on Mt. Gox, the largest bitcoin exchange, stood at ~10,000. That's 10,000 new customers who are most likely not trying to sign up so they can sell bitcoins they already own. As word spreads, newcomers inevitably arrive.

Newfound resilience

In the past, bitcoin was at its most vulnerable when the system was destabilized. In the summer of 2011, a series of hacks caused bitcoin’s value to plummet below $2. Those destabilizing factors are still present, but the bitcoin market is responding differently this time around.

We’ve seen a major software glitch create a fork in the blockchain. Instawallet was just hacked and is now out of commission indefinitely. And Mt. Gox recently released a statement on Facebook explaining that the company’s downtime over the last 24 hours was the result of a malicious DDoS attack, either a bout of bitcoin terrorism or an abuse of the system in search of profits.

In spite of all of this, bitcoin’s price levels have persevered. There’s been definite volatility, but there’s been no crash and no one has panicked. Bitcoin currently sits at a still lofty ~$136. The more times bitcoin weathers such hiccups, the more credibility the ecosystem earns, and the safer people will feel holding onto the things, which ultimately allows everyone to pay less attention to short term speed bumps and pay more heed to long term potential.

The market is tiny, but interest is huge

In real terms, bitcoin is a joke. Even at the current price, which feels huge, bitcoin’s total market cap is still not much more than $1 billion. That’s about 0.006 percent of the $16 trillion U.S. economy. In other words, bitcoin as it stands is irrelevant. It’s a novelty. Mark Zuckerberg is worth more than all the bitcoins in the world.

Meanwhile, people are freaking out about how much bitcoins are worth. It’s crazy! It’s ridiculous! But it’s also miniscule. A story I heard the other day: Tradehill, one of the major bitcoin exchanges in the U.S., was upping its verification standards, which meant they now required their existing customers to hand over more information. One account had about $100,000 sitting in it. The customer told Tradehill to forget it and just keep the money, no big deal. We can only speculate who the customer was, and it's quite likely apocryphal, but the point is that for certain people in the world, bitcoin is child’s play.

The relatively low volumes mean high volatility and uncertain futures. But it also means bitcoin has a ton of room to grow and that even minimal hard interest can drive the price up. Since the number of coins is algorithmically maintained, there’s no central banker who can just print more coins, and as such there’s no way to immediately address the glut of demand. And as the price increases continue, so does the hoarding. As Joe Weisenthal notes, we're experiencing bitcoin hyperdeflation.

The Cyprus effect

The events in Cyprus have been an urgent reminder that our current systems aren’t nearly as secure as we always believed them to be. It's bad for consumer confidence, but good for bitcoin, since bitcoin isn’t regulated by some central authority and governments can’t really take your bitcoins away from you, as one Cypriot saver learned the hard way.

“Over 700k of expropriated money will be used to repay country's debt,” the owner of a “European medium size IT business” wrote on the popular forum BitcoinTalk. Probably we will get back about 20% of this amount in 6-7 years. The business is definitely ruined, all Cypriot workers to be fired,” he continued. “We are moving to small Caribbean country where authorities have more respect to people's assets. Also we are thinking about using Bitcoin to pay wages and for payments between our partners.”

One prominent bitcoin service provider who wished to remain anonymous notes that they have seen a 4-fold increase in Cypriot visits to the site from January to March versus October to December. In comparison, site traffic has only increased 1.3 times overall.

Meanwhile, central banks around the world continue in their policies of quantitative easing, a method by which central banks shove more money into an economy to try to spur growth. As with all forms of money creation, it comes with a risk of inflation. Japan, who recently joined the QE party, has now announced that the country will add 84,000,000,000,000 yen to the system per year. When your money gets devalued by governments trying to rescue the sinking ship that is the global economy, the classic safe haven is gold. But now there’s also bitcoin.

Government acknowledgement

But more than anything, bitcoin is rallying because of government-backed legitimacy thanks to the recent guidance from the anti-money laundering arm of the U.S. Treasury, FinCEN. No longer the uncertain plaything of crypto-hackers, bitcoin is suddenly legally accepted tender. Predictably, the government had been monitoring the situation all along, explained James H. Freis, the former director of FinCEN, who was present during the drafting of the recently issued guidance.

"The aspects of the emergence of virtual currencies is something that has been on the radar screen for years," Freis told me over the phone. Freis explains that the goal of the guidance is less about bitcoin (or other virtual currencies) itself but rather provide the necessary language to deal with those looking to exploit such platforms for criminal activities. In other words, the government doesn't have particular beef with bitcoin, only the criminals who abuse it.

One of the biggest worries has always been that governments could simply shut this thing down. With that outcome looking more and more unlikely, businesses and users alike can find comfort hopping on the bitcoin bandwagon. Investors, likewise, can find further confidence throwing their money at the digital currency’s potential.

And while Cyprus gets a lot of credit for putting a spotlight on the situation, it’s FinCEN that’s really responsible for getting all the money to flow, explains Erik Voorhees, a long time bitcoin advocate and entrepreneur.

“I doubt much is going on with Bitcoin in Cyprus, other than that everyone there is learning they should've kept their funds in Bitcoin instead of bank deposit euros,” Voorhees told me over email. “But it's too late for them now… no way to buy Bitcoins when your banks have shut off and you can't pull out cash from the ATM's. Bitcoin is exploding in places where purchases can still happen, but I think this has more to do with the FinCEN ruling than Cyprus.”

@sfnuop

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A Guide to Bitcoin Mining: Why Someone Bought a $1,500 Bitcoin Miner on eBay for $20,600