Bitcoin bubble 2013

Earlier this year, the price of the electronic currency Bitcoin exploded upwards, making its early advocates rich and smug and leaving everyone else shouting "bubble!"

Then, the price of Bitcoin crashed, making everyone who had cried "bubble" feeling smart and smug.

And then, a few weeks ago, the price of Bitcoin started exploding again.

And, so, once again, Bitcoin believers are crowing, and everyone else is mumbling about "bubbles."

So, who's right?

Most likely, everyone.

Why?

Because Bitcoin is the perfect asset bubble.

There is absolutely no way to value Bitcoin, which means there is nothing constraining its price other than supply and demand. As long someone new can be convinced to buy Bitcoin, its price can keep rising. Bitcoin prices could literally go to 1, 000 or 10, 000 or 100, 000 or 1 million per coin, and there would be no way to prove that these prices were ridiculous.

What's more, even if Bitcoin is a bubble, prices could keep rising for years.

As everyone who has ever been involved with asset bubbles can attest, they usually have a few defining characteristics:

• They usually have some basis in logic or theory (as Bitcoin does)
• They can last much longer and inflate much more than most people think (the current Bitcoin price rise might be only the beginning)
• They can make early adherents absolute fortunes
• They can go through many "mini-bubbles" on their way to becoming a massive bubble — with each new high exceeding the old high and each new low higher than the old low
• They can burst relatively suddenly, without any particular warning, and their collapse can wipe out almost all of the many years of gains.

The premise and promise of Bitcoin--the part that appeals to folks who don't happen to be gold bugs, conspiracy theorists, or cryptography geeks (obviously they all love it)--is that the plan is for only a finite number of Bitcoins to be created. This is in contrast to standard government-issued currencies, which governments can always print more of. If the supply of Bitcoins remains finite, this should theoretically eliminate inflation, which is one of the biggest drawbacks of paper money.

What has suddenly grabbed the public's attention about Bitcoin, however, is the recent explosion in the value of the currency.

Because the number of Bitcoins is limited, their value increases rapidly when more people want them. And when the value of something increases rapidly, even more people want them. So the initial price increases fuel future price increases which fuel more future price increases...at least for a while.

Of course, this dynamic has fueled the inflation of every asset bubble in history. So it behooves people to analyze the sustainability of such price increases carefully.