Bubbles of fun

Evan Jenkins, sitting in for Guan Yang, in turn sitting in for Noah Smith, writes, in a long exposition on Bitcoin, that it surely represents a bubble at this time. I want to focus on the two "confounding factors" Jenkins cites. I'm not sure if he meant that these factors confound his analysis, as I don't see that. It's more that these two facts confound the entire Bitcoin project (if "project" is the appropriate term).

Jenkins: (emphasis added)

The first confounding factor is that the Bitcoin market, as it exists now, probably does a pretty bad job of pricing correctly. The problem is that it is very difficult for somebody who does not already hold Bitcoins to make a bet against the future of Bitcoin. The only people with the power to move the Bitcoin market down are those who have already bought into the Bitcoin market, and they likely have rosier visions of the future of Bitcoin than the rest of us. This, in my opinion, is the biggest piece of evidence in favor of calling Bitcoin a bubble. In order for the Bitcoin market to price Bitcoin correctly, there needs to be a good way to short Bitcoins. But until there is a reliable way to lend and borrow in Bitcoins, that won’t happen. 

The second confounding factor is that if Bitcoin really does establish itself as a legitimate currency, we will need to throw our assumptions of how many Bitcoins there are out the window. In principle, there should be no more than 21 million Bitcoins ever produced. In fact, since Bitcoins can be irreversibly lost, we should actually expect the number of extant Bitcoins to start decreasing at some point. But, as much as the True Believers like to rail against fractional reserve banking, the truth is that once Bitcoins become a real currency, it will start being banked and invested like a real currency, which will effectively increase the number of Bitcoins in existence. Depending on how we measure total “amount of money” in US dollars is anywhere from 10 to 20 times the amount of physical currency in circulation. But there is reason to think that for Bitcoin, the mulitplier could be even higher, as Bitbanks would lack, at least initially, any sort of reserve requirement. This lowers the future price, and thus raises the probability, of the True Believer future. But is this the future that the True Believers want? Not really.

To my view, what Jenkins is saying here is that a future in which Bitcoins is a real currency that competes with what we think of now as real currencies, without the bummers inherent in real currencies like fractional reserve banking and governmental oversight (or literal control), is not a real future. In other words, the things that define modern currencies are the things that Bitcoin advocates seek to avoid. This is likely problematic if these advocates want to see Bitcoin compete with real currencies. If, on the other hand, Bitcoin settles into a comfortable role as a niche asset, like tobacco shares or Renoir paintings, then it will likely be a success.

Bitcoin is a neat throwback to the days of state banking with its minimal oversight, competing currencies, high transactions costs, wild price swings, and regular financial panics. Anyone who misses those days of sweet freedom is likely a Bitcoin advocate. None of this is to say that the system we have today is free from frictions and inefficiencies. My point is that, as fuddy-duddy as 21st century currencies like the dollar and the euro are, and as exciting as Bitcoin promises to be, who really wants their medium of exchange, their unit of account, or their store of value to be fun?