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Stephen Kinsella: Once bitten twice shy, so stay away from Ponzi-like Bitcoins

Sometimes in economics it feels like we simply jump from one bubble to another, learning nothing as we go. During a session on new forms of money at the Kilkenomics festival, the subject of Bitcoins came up.

It is a virtual currency which exists on peer-to-peer networks. The room was full of people who had bought the stuff, delighted its price had increased by several thousand per cent in the past year. I pointed out that while some people were getting very, very rich, this was precisely because the market for Bitcoin was a bubble. And what do bubbles do? They burst.

My deep and terribly clever insight was about as welcome as a fart in a spacesuit to the Bitcoin faithful. But you don't need a PhD in economics to realise this: we've lived through a massive bubble, and we know what happens when it bursts. Look around you.

So why, then, are Irish people helping to inflate yet another one?

Bitcoin accesses a certain idea of stateless money. It is a currency not backed by any state – meaning nobody has to take it as payment – and luckily for us as taxpayers, when the market for it collapses, the State won't be asked to step in to save its owners.

Bitcoin is actually 'mined' online and the supply of coins, we are assured, grows at a predictable rate. What is unpredictable is the price at which people are willing to buy and sell. Bitcoin prices are highly volatile. You can use online exchanges to convert your mining efforts into other currencies, or buy the Bitcoins mined by others using your own currency.

Karl Marx urged us to think of commodity value in terms of use value and exchange value. Think about your house. You live in it, so you get value from its use. If you sell it, you'll realise some exchange value. Bitcoin has no use value, only exchange value, and because it is has no worth in use other than what others are willing to pay for it, it is always in a bubble: these happen when prices of assets get dislodged from their fundamental value. So Bitcoin is the perfect bubble.

I have no problem with informed, rational investors speculating on an asset in a rising market. Take your profits if you can. Just spare me the 'future of money' pravda. There's nothing new here beyond the cool software implementation.

Bubbles form when expectations about price increases from an asset outpace any possible returns it can make on its own. You make money from 'flipping' the asset to somebody else at a higher valuation, or you might not.

If the game of 'virtual pass the parcel' stops and you're the one holding it, well, tough. This is an asset with no underlying value – it exists in a purely psychological space. Investors buy and hold it because they think other people are running behind them into the market to bid the price up. Today's buyers will be tomorrow's sellers.

Doesn't it all sound very familiar? That is exactly what happened to Ireland.

The economist Hyman Minsky divided borrowers and investors into three types: the upstanding sort that can pay principal and interest; speculative borrowers (he called them 'units'), who can pay interest but have to keep rolling the principal into new loans; and 'Ponzi units' which can't even cover the interest, but keep things going by selling assets and/or borrowing more and using the proceeds to pay the initial lender.

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Minsky wrote that, "over a protracted period of good times, capitalist economies tend to move to a financial structure in which there is a large weight of units engaged in speculative and Ponzi finance. The result is financial instability".

The Bitcoin movement is also being driven and hyped online by those with a definite financial interest in keeping the price of these things skyrocketing. Because it has no value beyond what people are willing to pay for it, its price may go up hugely in the coming years, making many people very rich on their screens if not on paper.

And then it will crash, making many people very poor. I really hope readers of this column recognise the Bitcoin experience for what it is: a speculative play within a digital Ponzi scheme. Get involved if you like, but understand there are more productive uses of your money which could be used to create jobs in the real economy, too.

Matthew Arnold wrote in his poem 'Absence' "and we forget because we must, not because we will".

In this case I think Arnold is wrong. Bitcoin buyers are willing themselves to forget the fundamental rule of unsustainable processes: they stop.

Dr Stephen Kinsella, senior lecturer in economics, University of Limerick.