Wednesday, October 8, 2014

I Want You to Hoard Bitcoins

Bitcoin has been going through some interesting times lately. A year ago, the price of a bitcoin was about $120. A short time later, a period of rapid growth began, and on November 29, a record high was reached at $1,242. That was when a lot of people suddenly started paying attention. Since then, it has been highly volatile and it is now hanging around $340. Should I be worried?





I have been studying a lot of economics as it relates to Bitcoin and, because of that, I have become quite optimistic. Allow me to briefly explain. 
No one can dispute that Bitcoin has become a medium of exchange, even in the face of daunting competition like national currencies that enjoy huge advantages due to their legal status (taxation and legal tender laws) and the network effect (national currencies have been around a long time so people are used to them and are resistant to change). Despite its disadvantages, Bitcoin grows because it is a superior currency and national currencies get worse and worse due to their terrible management. As long as other currencies exist, there is no limit to Bitcoin's growth. So how do we help it grow? We buy bitcoins and we hoard them.



First, let us look at what happens when hoarding does NOT occur. When someone tells you to "support the Bitcoin economy", what they usually mean is that they really want you to spend your bitcoins. They believe that this is a good way to help the currency grow. However, if everyone was constantly spending their bitcoins, that would signal to the market that nobody actually wants them. As the velocity of bitcoins (how fast a bitcoin passes from one holder to the next) approaches infinity, the price of bitcoins approaches zero. This does not help the Bitcoin economy. What can be done? Hoarders to the rescue!


When people buy bitcoins and hold them, the higher demand causes the price to climb and the market cap of Bitcoin (the value of all bitcoins combined) goes up. The higher market cap increases the liquidity of Bitcoin (if something is highly liquid it can be bought and sold quickly without affecting its price). As the liquidity of Bitcoin increases, its actual utility is also increased since you can transfer more value with bitcoins than you could before (right now it is impossible to transfer 5 billion dollars' worth of bitcoins - a higher market cap would allow more). The increased utility of Bitcoin gives it more value and, therefore, attracts more people that want to buy it. This hoarding feedback loop is why Bitcoin will most likely absorb all the other currencies on the planet. This growth happens in spurts, as we have seen, so I am trying get people on board before the next growth spurt. So, what are you waiting for? Go buy some bitcoins and hoard them well!




Edit: A spend-and-replace approach is completely consistent with what I have discussed here. You can hoard and "support the Bitcoin economy" by purchasing stuff with bitcoins and then instantly replacing those bitcoins.

5 comments:

  1. One bad part of hoarding is the bitcoin ecosystem needs to be engaged. So if you're hoarding, you're not using. Hoard and spend. That's the way to go!

    ReplyDelete
    Replies
    1. I'm a big fan of the spend-and-replace approach. Buy whatever you want with bitcoins, but then buy enough bitcoins to replace what you just spent.

      Delete
    2. There is still an opportunity cost to the spend-and-replace approach. Bitcoins that are spent cannot also be hoarded. For maximum hoarding results, lower your time preference and hoard as much as you can.

      But one's time preference cannot be lowered infinitely, one has to consume at some point or you'll go crazy (or starve). Remember, 20 years from now the financial decisions you make today will have a significant impact.

      Delete
  2. I am hoarding bitcoin... my whole entire 1 bitcoin... haha. I've bought and sold many times, but I always keep 1 whole coin because... well, you never know.

    ReplyDelete
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