What's the Big Deal with Bitcoins?

            Bitcoins…bitcoins...bitcoins!  It seems like the world has all of the sudden, or at least as of early this year, become entirely enamored with bitcoins as evidenced by the overwhelming press coverage they have been getting recently.  I don’t know how I managed to get this far in the year without writing about it because it has been a fascinating phenomenon to watch unfold.

            Recall from the end of my last post that bitcoins are an open-source fiat money that is backed by no government or bank, but rather the citizens of the internet.  It is the most fiat of money for that very reason.  Bitcoins have been around for several years, beginning in 2009 and growing slowly in popularity since then.  The exchange rate of dollars to bitcoins began 2013 at around $13 and rose to an all-time high of $230 by April and then dramatically crashed before leveling off around the hundred dollar mark where it sits now, several months later.  What happened in those months that caused the sudden bubble and bust?  I have a theory: an educated guess, if you will based on a little reading and some mental puzzle-solving.

            Bitcoins have been used primarily for ecommerce transactions of illegal goods because they are, by design, international and anonymous (or at least very difficult to track).  Drugs, firearms, fake IDs, and rather significantly more unsavory goods are dealt through illicit marketplaces with bitcoins being used as the medium of exchange, internationally and anonymously like the buyers and sellers themselves.  Hold that thought in the back of your mind.

            What was going on in the world in early 2013, culminating in March?  The European financial crisis had hit Cyprus pretty hard.  I even wrote a post about the whole incident when it was happening.  Cyprus is a tax haven for Russian business magnates and so one of the things that was suggested by the ECB/IMF/European Commission during the early weeks of March (March 16^th to be exact) was to confiscate 40% of the bank deposits of uninsured accounts with a value over 100,000 Euros: essentially targeting the Russian businessmen.  This idea was eventually dropped on March 25^th, but during the days between the 16^th and 25^th, the fate of those deposits were up in the air.  

            Before looking at the exchange rate graph below, take a wild guess as to when the bitcoin boom started, recalling that bitcoins are the de facto underground market currency and that a substantial portion of Russia’s economy is built on the dealings in such markets…and that Cyprus was a tax haven.

            If you guessed that the dramatic boom started in the third week of March, you’d be correct!  Bitcoins had been increasingly in the public eye since the beginning of the year but the major step up began when the deposits were threatened by seizure.  I suspect that the rest of the world noticed the inflation and speculators carried the bitcoin’s value to its highest point even after the deposits’ threat had gone away.  Examine the graph for a while and see if you can’t extract more insight from it.  The events of the past few months on the web and in the rest of the world are more interesting than ever and I suspect we can learn about how humans deal with booms and busts by seeing the bitcoin crisis as a microcosm of what has happened, and maybe will again, for other securities and currencies in the rest of the world.

By the way, the exchange rate chart can be made here where you can manipulate the time frame as well as several technical indicators.