A bitcoin bubble could be good for everyone

By Adam L. Penenberg , written on May 17, 2013

From The News Desk

The president of Western Union scoffed at the invention of the telephone, calling it little more than an “electric toy,” and the company informed Alexander Graham Bell that his brainchild to place one in every home was “utterly out of the question.” A couple of years later, Oxford University professor Erasmus Wilson predicted that when the 1878 Paris Exhibition closed, the electric light would “close with it and no more will be heard of it.” When Henry Ford sought investors for his car company in 1903 a Michigan banker advised his client against it, forecasting that “the horse is here to stay, but the automobile is only a novelty.” In 1946, Darryl Zanuck, president of 20th Century Fox, said, “Television won't be able to hold on to any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.”

Throughout history, great technological innovations – the sort that fundamentally change business, culture, and life itself – must overcome initial skepticism. Once it does, a pattern emerges. Entrepreneurs recognize its potential for disruption and start businesses, which attract consumers and newcomers who join the party, bringing with them investment. The media writes about it breathlessly. All of this together works to pump air into the bubble as some companies go public and their stocks soar in a speculative frenzy.

Ultimately reality sets in. After burning through cash, companies fold, leaving investors to wonder when and how someone will actually make money. Optimism turns to pessimism. Stock prices crash, investment dries up and this entire sector is given up for dead, until, over time, the core technology is woven into the fabric of life. It’s a cycle of boom, bust, and sustained growth, followed by the inevitable decay when someone figures out how to build a better mousetrap.

While bubbles get a bad rap they are a necessary stage of technological development. They yield ancillary cultural benefits, which are pervasive through history -- movements or revolutions the real importance of which end up being something quite peripheral to the main thrust of the movement's ideology. With that in mind, are we at the onset of a bitcoin bubble?

It does have all the characteristics. Since February 2009, when it was first introduced, bitcoin has overcome initial skepticism and gone from mere curiosity to a billion-dollar market. About 11 million bitcoin have been mined since the crypto-based currency was introduced, and at a price of $115, it has a combined value of $1.3 billion. As the money supply has increased, so too have the number of businesses that will accept bitcoin. Investment is beginning to flow to companies trafficking in the currency. Recently Union Square Ventures announced a $5 million investment in Coinbase, which operates as an exchange. Liberty City Ventures, another New York-based VC firm, has a $15 million bitcoin fund to invest in startups. Boost VC plans a Bitcoin-related seed fund. Peter Thiel’s Founder’s Fund, is leading a $2 million round for BitPay, a businesses payments processor that works with bitcoin.

Chris Dixon, a partner at Andreessen Horowitz, thinks that bitcoin could be the next big thing. At the recent Pandomonthly in New York, he claimed it had the potential to revolutionize online commerce, which is plagued with fraud.

So what’s next for bitcoin? Well, if it follows the same boom, bust, and beyond paradigm as railways, cars, and dot coms, we’re in for an interesting ride. And even when the bubble pops – and it will inevitably pop – it will likely leave behind something quite valuable.

After railroads supplanted canals as a hot investment in the early 19th century, the number of railroads spiked. Between 1825 and 1826, as many railroads were founded as had been created in the previous 20 years. When the market crashed, it crashed hard, and by the mid-1870s, 40 percent of American railway bonds were in default. At the turn of the 20th century there were hundreds of automobile makers in the United States. Money and resources poured into them, yet most went out of business until there were only a few left. And we all know what happened during the dot com bust, which weighed down the America’s economy for years.

But these bubbles weren’t for naught. Before the railroad crash, 45,000 miles of track had been laid and by 1900 a national network of more than 200,000 miles long helped the United States grow and prosper. The boom and bust of the automobile industry led to the creation of roads, and ultimately a national highway system. The dot com bust left in its wake significant investments in broadband ­that made Web 2.0 and the rise of Facebook and other online businesses possible.

Because, you see, capacity, or rather overcapacity, is the key to progress. And even when bad things happen, which does when bubbles burst, good can come out of it. The recent credit bubble was devastating for the economy, true, but on the bright side more Americans than ever now have access to credit than they did before. A small gift, no doubt, and probably not worth the pain, but a gift nonetheless.

In the next few years, if the US government doesn’t try to stamp out bitcoin, it will follow a similar course. And when the bubble bursts – if it manages to get to that point – an entirely new currency will have taken root with a vast infrastructure to support it.

First, though, more air must be pumped into the bitcoin bubble. And there’s a whole lot more room before it will pop.

[Illustration by Hallie Bateman]