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The Cryptocurrency Explosion

I do not know that much about cryptocurrency yet but I will take a stab at discussing it as even some “official” sources seem wrapped up in one hysteria or another.  The people who write for zerohedge, for example, live and breathe investing but always seem to write about how the world is ending.  I guess perpetual clickbait is a good business model for them.

Even tech-savvy people are calling cryptocurrency a “bubble” but I don’t think that’s the right way to think of it.  There’s a clear demand and niche for the value it provides.  These currencies are just now reaching a point that normal people can use them easily and a critical mass of businesses and organizations are adopting them. 

So the huge explosion of cryptocurrency over the last year is not so much a bubble as it is the Atlantic spilling past the Pillars of Hercules and filling up the basin of the Mediterranean.

The question is not when it will burst but when it finds its natural level and reaches a steady equilibrium.  How much water does the Mediterranean hold?  I’m very far from being expert in anything financial but I casually notice world bond markets hold 10s of trillions of dollars and precious metals contain well over 10 trillion dollars worth of value.  World-wide derivatives are somewhere in the hundreds of trillions.  The market cap for all cryptocurrencies combined only approached 500 billion dollars in the last day or so.  I could imagine that as a mature sector, cryptocurrency ought to hold at least a few trillion. 
That said, even as the Mediterannean sea fills up, I can anticipate there will be plenty of volatility between cryptocurrencies.  Right now, I suspect bitcoin is golden because everyone is using it.  It might be the microsoft windows of cryptocurrency, for a little while.

Unlike operating systems, cryptocurrencies don’t have as much of a moat.  There’s little to stop a business from accepting multiple crypto-currencies.  Also, bitcoin is way too slow and it already has many alternatives, even bitcoin cash, a more scalable hard fork of itself out there. Bitcoin alone is worth more than all the other cryptos combined which is pretty impressive, but that’s still a lot of market share out there it doesn’t control which has also been growing.

The real killer about bitcoin’s slow transaction speed is miners will be able to blow up fees for priority customers to get to the front of the line until bitcoin becomes the San Francisco, Manhattan, or Arlington of cryptocurrencies.  As wait time and fees mount, the pressure rises to spread ballast to other crypto-currencies, especially those that have been specifically engineered for better scalability.

So the real question regarding bitcoin is how strong the network effect is before it starts to settle into equlibrium with other cryptocurrencies.

Using Bitcoin To Avoid US Poker Laws

Here is an interesting step that might broaden the market for bitcoins. Right now bitcoins fails a simple convenience test – it can take an hour or more to convert the money into bitcoins. Now an online poker store has added bitcoins as a form of payment, giving it a much wider reach:

http://www.businessweek.com/articles/2013-01-03/bitcoin-making-online-gambling-legal-in-the-u-dot-s-dot

“Michael Hajduk had sunk one year and about $20,000 into developing his online poker site, Infiniti Poker, when the U.S. online gambling market imploded. On April 15, 2011, a day now known in the industry as Black Friday, the U.S. Department of Justice shut down the three biggest poker sites accessible to players in the U.S., indicting 11 people on charges of bank fraud, money laundering, and illegal gambling. … Infiniti Poker … plans to accept Bitcoin when it launches later this month. The online currency may allow American gamblers to avoid running afoul of complex U.S. laws that prevent businesses from knowingly accepting money transfers for Internet gambling purposes. ‘Because we’re using Bitcoin, we’re not using U.S. banks — it’s all peer-to-peer,’ Hajduk says. ‘I don’t believe we’ll be doing anything wrong.'”

Hajduk says the ability to store Bitcoins on players’ computers is appealing. “At the end of the day, [the government] cannot freeze your account because they cannot kick down the door to Bitcoin,” he says

There are other risks as well. In recent months hackers have pulled off several Bitcoin heists, and this summer Bitcoin Savings & Trust, billed as a “Bitcoin hedge fund,” made off with more than $5 million entrusted to the site by investors, in what appears to be a Ponzi scheme. Also, Bitcoin wallets can vanish as a result of hard-drive crashes or other computer problems. That’s how at least one user lost 50,000 Bitcoins, according to Peter Vessenes, chairman of Bitcoin Foundation, an organization that helps develop and promote the virtual currency.

The economy for the infamous SilkRoad is much smaller than the 1.5 trillion+ profits that come from the international drug trade:

http://arstechnica.com/tech-policy/2012/08/study-estimates-2-million-a-month-in-bitcoin-drug-sales/
Silk Road sellers have collectively had around $1.9 million of sales per month in recent months. Almost 1,400 sellers have participated in the marketplace, and they have collectively earned positive ratings from 97.8 percent of buyers. And the service is growing, with Silk Road’s estimated commission revenue roughly doubling between March and July of this year.

The current market price for all existing bitcoins is estimated at over $100 million.

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