When the speculators flee, what will be left of Bitcoin?

The underlying currency might not work without the inflated prices.

Last week's post pointing out bubbly appearance of Bitcoin's market capitalisation sparked some kickback. That was to be expected; in any bubble, people who are currently exposed to the possibility of a crash are unlikely to take the news well. Bitcoin has even more die-hard defenders than most bubbles, though, because of the mixture of political and cultural factors which cause a lot of people to invest such hope in it.

Amongst the currency's fanbase – and the fact that a currency has a fanbase is itself notable – are libertarians who decry any government involvement in the free market, techno-utopians who love the idea of fully digital money, monetary hawks who like the fact that the success of bitcoin would basically end inflation, and, frankly, criminals who like a completely untraceable currency (I'm not implying that if you like an untraceable currency you must be a criminal, but there's no denying that Bitcoin is a big deal for sites like Silk Road), as well as your common-or-garden speculators. All of them (except maybe the criminals) have a bigger reason to hope for the success of Bitcoin than just financial: if it succeeds, it proves them right.

But I fear that there are very few arguments which can be made to prove the Bitcoin boom that we're seeing right now – which has resulted in a 250 per cent increase in the total value of the Bitcoin economy in just three months – isn't a bubble. The problem is that there is not really anything to point to in that time period to explain the massive increase, except the massive increase itself. So it may be comforting for Bitcoin fans that there is a Bitcoin hedge fund in Malta, but given that that hedge fund exists because of the boom, not the other way round, it doesn't explain anything.

In fact, in the last few months, there have been a few news events which ought, by rights, to reduce the value of the currency. Chief among them is the fact that the block chain – the distributed record of every Bitcoin transaction, and the technical underpinning of the entire things – forked earlier this month, something it should not be able to do.

A transaction was made using a new version of the software, which was too large for earlier versions to handle. As a result, some clients accepted it, while others rejected it, leaving two valid block chains circulating. Some users are pointing to the fact that the currency is still circulating largely unaffected as a sign of its strength, but that's a bit like saying that the fact that your plane is still flying after its engine exploded makes the explosion good news.

The best way to justify the exponential increase in the market capitalisation of Bitcoin would be to point to a similar exponential increase in people using the currency to perform their everyday lives, and that simply hasn't happened. Take-up is strong, but nowhere near the level it would need to be to explain a half-billion market cap. Whereas speculation – people buying Bitcoin low to sell high – does.

(Note too I'm not saying that the currency is a Ponzi scheme, an accusation often levelled at it over the fact that the first holders of bitcoin had the most to gain from talking it up to others and then selling high. A bubble isn't necessarily the same as a Ponzi scheme, even a bubble which is deliberately engineered to reward its first buyers, and I don't think Bitcoin has those characteristics.)

The natural price of Bitcoin is far, far lower than where it stands right now, probably around the same level it was last summer, after its first catastrophic crash and before its second. The real question for the currency isn't whether it can survive being an investment for speculators – it can't – but whether it can survive as a currency when valued at 10 per cent of what it is currently.

The problem it faces is that the distributed computing which lets Bitcoin work is expensive. It takes energy, and time, and frequently also specialised hardware. The reward for doing so – "mining", in the parlance – is a randomly allocated share of the new coins produced through inflation. As time goes on, the currency will produce less and less extra coins this way, but for now, the bigger fear is if the natural price for Bitcoin can go low enough that it no longer becomes efficient to run these mining rigs.

There are still ways of getting around that – the technology allows for the payment of what is essentially a processing fee on top of each transaction – but it may be the case that Bitcoin's use as a currency is currently being subsidised by its bubble-tastic value. Hopefully the two are separate enough that even after the crash, Bitcoin can continue to function as an alternative way to send money over the internet. But the more Bitcoin fans boost the bubble, the bigger the shock's going to be when it pops.

The Bitcoin logo.

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Photo: Getty Images
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David Cameron's starter homes: poor policy, but good politics

David Cameron's electoral coalition of buy-to-let retirees and dual-earner couples remains intact: for now.

The only working age demographic to do better under the Coalition was dual-earner couples – without children. They were the main beneficiaries of the threshold raise – which may “take the poorest out of tax” in theory but in practice hands a sizeable tax cut to peope earning above average. They will reap the fruits of the government’s Help to Buy ISAs. And, not having children, they were insulated from cuts to child tax credits, reductions in public services, and the rising cost of childcare. (Childcare costs now mean a couple on average income, working full-time, find that the extra earnings from both remaining in work are wiped out by the costs of care)

And they were a vital part of the Conservatives’ electoral coalition. Voters who lived in new housing estates on the edges of seats like Amber Valley and throughout the Midlands overwhelmingly backed the Conservatives.

That’s the political backdrop to David Cameron’s announcement later today to change planning to unlock new housing units – what the governmen dubs “Starter Homes”. The government will redefine “affordable housing”  to up t o£250,000 outside of London and £450,000 and under within it. and reduce the ability of councils to insist on certain types of buildings. He’ll describe it as part of the drive to make the next ten years “the turnaround decade”: years in which people will feel more in control of their lives, more affluent, and more successful.

The end result: a proliferation of one and two bedroom flats and homes, available to the highly-paid: and to that vital component of Cameron’s coalition: the dual-earner, childless couple, particularly in the Midlands, where the housing market is not yet in a state of crisis. (And it's not bad for that other pillar of the Conservative majority: well-heeled pensioners using buy-to-let as a pension plan.)

The policy may well be junk-rated but the politics has a triple A rating: along with affluent retirees, if the Conservatives can keep those dual-earner couples in the Tory column, they will remain in office for the forseeable future.

Just one problem, really: what happens if they decide they want room for kids? Cameron’s “turnaround decade” might end up in entirely the wrong sort of turnaround for Conservative prospects.

Stephen Bush is editor of the Staggers, the New Statesman’s political blog.