Guide to Crypto-Currencies Part 2: The Bitcoin Bubble


A volatile investment

Any investment that gains 10,000% in value within the space of 11 months has to be considered the buy of the century, and that is how Bitcoin was widely viewed. However, Bitcoin’s rise was bumpy indeed, and the exchange rate remains incredibly volatile. With speculation driving much of the movement, and the hype levels at fever pitch, it was inevitable that bubbles would form and burst with increasing frequency.

For example, during the banking crisis in Cyprus, Bitcoins soared in value from around $40 to north of $200 within the space of a few weeks, only to crash down to around the $60 mark when the crisis was averted. In March, the government of Cyprus announced a bank bail-in, which meant that financial institutions would be forced to impose their losses on shareholders, debt-holders, and large depositors.

As you might expect, a massive bank run followed, with people rushing to withdraw money from their bank accounts and invest them in Bitcoin – a currency over which the government had no control or oversight.

Cyprus and China lead the way

With banking crises popping up all over the world, and public trust in the banking and monetary systems at an all-time low, the precedent set by Cyprus prompted many people to look upon crypto-currencies in a new light. Here was an alternative to fiat currencies that the governments and central banks couldn’t meddle with. And this is what made it attractive to people in China.

In China, there was a huge level of interest in Bitcoin among the middle classes, who were finding it very difficult to invest overseas because of China’s restrictive financial system. This is something that a lot of people wanted to do, because the country had a massive stock market and real estate bubble, which made domestic investments look distinctly unwise.

But, in the end, the bubble that this created for Bitcoin was of greater magnitude than either of these. During October and November, the price just kept going up and up, and soon Bitcoin’s dramatic rise was all over the newspapers.

What goes up…

Then, predictably enough, the bubble burst. The Chinese government announced that it was cracking down on Bitcoin use, putting the brakes on its increasingly mainstream acceptance in Chinese society. Prices dropped dramatically, and this trend was reinforced a few months later with a string of cyber-attacks affecting Bitcoin exchanges – including the biggest of them all, Mt. Gox.

With hundreds of millions of dollars worth of Bitcoins suddenly going missing due to a security flaw known as ‘transaction malleability” – confidence in crypto-currencies went through the floor. At the time of writing, Bitcoin is trading at $460 – around a third of its November 2013 peak. So it’s down, but not out by any means. In the next part of this series, we’ll be taking a look at how virtual currencies such as Bitcoin work, the advantages that they can bring, and the questions that they raise.

Other articles in this series

Guide to Crypto-Currencies Part 1 – Introduction
Guide to Crypto-Currencies Part 3 – How Bitcoins Work
Guide to Crypto-Currencies Part 4 – Bitcoin Mining
Guide to Crypto-Currencies Part 5 – Transactions
Guide to Crypto-Currencies Part 6 – The Problem(s) With Bitcoin
Guide to Crypto-Currencies Part 7 – Solutions to Volatility
Guide to Crypto-Currencies Part 8 – Security Issues
Guide to Crypto-Currencies Part 9 – Bitcoin Alternatives
Guide to Crypto-Currencies Part 10 – The Future of Money?