Matt Yglesias: Bitcoin Will Spiral Up and Down Forever

Matt Yglesias explains why the scheme will prove useless:

Tim Lee makes what is I think the strongest case for Bitcoin, arguing that it’s not just a fad, it’s a disruptive technology that can serve as a platform

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But where I think the analogy breaks down is with deflation. As computers started looking more and more useful and demand for computers grew, the world started building more computers. Bitcoins are deliberately designed to represent a finite supply. So if over time more and more people want to use Bitcoins to conduct transactions of various kinds, then the price of bitcoins is going to have to rise and rise. The problem is that if the price of a bitcoin is on a steady upward trajectory, then nobody’s actually going to want to spend a Bitcoin on anything. And if everyone’s hoarding their Bitcoins, then the network is actually useless. Then, since it turns out to be useless, you get a crash. The funny thing is that once the upward spiral comes to an end, then the technological virtues of the Bitcoin platform come to the fore again. If nobody wants to hoard Bitcoins, then Bitcoin-as-platform looks like an attractive alternative to elements of the payment system. But when Bitcoin starts looking attractive again, you should get a renewed hoarding cycle.

To put it in more jargony terms, expectations about the price level will be ‘unanchored’ instead of rapidly mean-reverting, so its going to be very difficult to ever have a platform that attracts a steady user base rather than a boom-and-bust cycle.