The Bitcoin Economy Is Collapsing With No Sign of Recovery

When Newsweek/The Daily Beast's Dan Lyons wrote about Bitcoins back in mid-June, that was a sure sign the digital currency had reached the mainstream. Now many readers -- from 70-year-old retirees to those drawn in by the newsweekly's cover that issue -- who might otherwise never have heard about Bitcoins, were aware of this completely anonymous form of money.

In that brief piece, Lyons lionized Bitcoins. "For the first time, you can buy anything online without giving your credit-card numbers or bank-account information -- leaving no trace at all," he wrote. But maybe the long-time technology reporter was too late to this story. It looks like the age of the Bitcoin could already be nearing its end.

Earlier this year, the price of the Bitcoin climbed to a high of $32. It then fell to about $18, which is where it stood when Lyons wrote his piece. But then it continued to fall. Just this past week, the first of August, the exchange rate dropped from $13.50 to under $7, as the chart embedded above shows. And it looks like it will continue moving in a downward direction.

The problem with Bitcoins is the same thing that people love about Bitcoins: They leave no trace. It takes an incredible amount of computing power to create new Bitcoins with a PC (you can also, of course, just buy them on an exchange, which is what most people using them do). And a complicated algorithm keeps the total supply steady. Once these digital coins are created, they're still just a handful of bits and bytes, a little piece of encrypted code. There is no fundamental value.

"You can always live in a house regardless of what happens to the real estate market, so we can be confident that house prices won't fall to zero," Timothy B. Lee pointed out this weekend over at Forbes. "Similarly, if the price of gold fell too much, people could always use it to make jewelry, so gold is a relatively safe investment."

But Bitcoins are nothing. You can't live in them and you can't wear them. You can't turn them into real estate or jewelry. Right now, you can use Bitcoins to buy books and computers and other goods and services, including, most famously, illegal drugs. But when -- if -- the exchange rate crashes, you can bet that those merchants will stop accepting Bitcoins, that the Tor-accessed websites will shut down. "[T]here's no significant community of people who conduct commerce exclusively (or even primarily) in Bitcoins," Lee pointed out. "And this means there's no logical stopping point to Bitcoin's price decline. So far Bitcoin enthusiasts have been buying Bitcoins as the price falls, convinced that the price will go back up eventually. But as the hoped-for rally has failed to materialize, more have gotten discouraged or bored and cash out, pushing the price down further."

Graph: Bitcoin Charts.