Bitcoin's Speculative Bubble Burst This Year — Technology Was No Match for Greed and Fear | 2018 Software of the Year

Bitcoin, and the kind of cryptocurrency that copied it, essentially retraced the tulip's curve this year.

Near the end of the year, something big happened in the software industry. Microsoft's market cap passed Apple's in late November and has stayed ahead since — the first time it has taken the lead back since Apple overtook it eight years ago.

But this wasn't because of some new Windows phone operating system. It was because cloud-computing products sold to businesses kept growing. Today's Microsoft is basically a company like IBM: it uses customer relationships built over decades to sell businesses software that ordinary users never see.

The stream of new apps set off by the iPhone and Android keeps thinning. The two highest-grossing apps on Apple's App Store this year were Netflix and Tencent Video, and what matters about them is not the software but the more than $10 billion worth of shows behind it.

Apple's and Google's own year-end lists were just as thin. Apple's pick for the new trend was "self-improvement apps." Google simply named its own YouTube TV app of the year.

As we noted in this year's hardware roundup, consumer products no longer drive growth. The software industry is short on invention, but the world is not short on shocks caused by software, and none was bigger this year than Bitcoin — a digital currency built on a blockchain database, and through and through a product of the software age.

From $20,000 a coin to under $4,000: this year Bitcoin repeated the tulip's bubble curve

Over the past two years, Bitcoin has swung wildly. On December 16, 2017, its price reached an all-time high of $19,650, twenty times what it cost at the end of 2016, when it was under $1,000. Multiply that peak by the 17.42 million bitcoins mined so far and every bitcoin in existence was worth more than $340 billion, close to Alibaba's market cap.

In 2018 the price has shaken its way downhill. A bitcoin now costs just $3,747, down 80% from last December's peak. All the bitcoin in the world is worth about $65.3 billion; nearly $280 billion has evaporated. At an estimated 20 million bitcoin investors, that is an average loss of $14,000 each.

In the ten years since it appeared, Bitcoin has gone from a worthless string of digits to an investment Wall Street could not ignore, one that pulled in $300 billion worldwide, set off fierce argument in finance, shook the share prices of listed companies, and destroyed enormous amounts of wealth. No company's software had a bigger effect this year.

Caught up in it are not only the 20 million-plus investors but also the miners and the firms that build mining rigs. Mining means selling computing power in return for bitcoin rewards. In late November, the price of bitcoin fell below the cost of the machines several times — that is, mining one bitcoin now costs more than the coin is worth. The three big mining-rig makers that filed IPO prospectuses in the first half of the year and reported fat profits — Bitmain, Canaan Creative and Ebang International — may not only fail to list but struggle to survive.

Traditional financial institutions joined the party just before the crash. In May 2017, Goldman Sachs said it was preparing to trade bitcoin. In December 2017, bitcoin futures started trading on Wall Street and hit their daily limit up twice on the first day.

As for the other digital currencies that appeared fast and vanished just as fast, no one can count them any more.

From the long stretch of worthlessness at the start, to the sudden climb in 2017, to the selling, the rebound and the shaky decline of 2018, the value of Bitcoin has drawn a fairly complicated curve.

Its rises and falls look much like classic bubbles such as the tulip and the South Sea Company:

In the 1500s, the Dutch adored tulips and could not grow them fast enough, and the price of a bulb climbed to frightening heights. The profits drew in every kind of investor. Nearly everyone in the market — from craftsmen of modest means to high society — wanted to stockpile bulb contracts while the market was good and sell out at the right moment. Between the end of 1636 and February 1637, bulb prices rose tenfold; some people were willing to trade a house for one bulb.

But a tulip creates no value, and as demand dried up, prices that had run to unsustainable levels collapsed within weeks.

A century later Sir Isaac Newton, who discovered the law of universal gravitation, walked into another enormous bubble.

In the 1720s the great physicist sold all his South Sea Company stock at a 100% profit, about £7,000. That was the peak of the South Sea Bubble. Newton thought the market had lost its reason and could not understand the madness of the investors in it: "I can calculate the motion of heavenly bodies, but not the madness of people."

Less than a month after selling, carried along by the market's fever, he bought back into the South Sea Company at a far higher price than he had sold at, and lost £20,000 — about $3 million today.

Benjamin Graham, Warren Buffett's teacher, recorded that episode in The Intelligent Investor as proof that a first-rate mind is no defense against human greed. Yet during the Great Depression Graham repeated Newton's mistake, tried to buy the bottom after the American market crashed, and lost everything he had.

Behind Bitcoin there is software: blockchain, a technology said to be capable of challenging the modern financial system, decentralized and hard to regulate, nothing like a plant bulb or a company's shares. To investors buying and selling it in a gambler's frame of mind, none of that made any difference. What moves it is human nature, not technology. In the end it behaved no differently from tulips or South Sea stock — the same bubble in another era and another form.

Bitcoin came with a story about technology, and a slow start

Bitcoin began with a fine-sounding vision, a story about technology changing the world.

In 2008, as the financial crisis swept the world, Satoshi Nakamoto wanted to make a "currency" that no government or other central authority controlled and that could never be over-issued, one that would stay clear of the crises that arrive every few years and become a form of property no one could take from ordinary people. In a white paper of just 13 pages he described Bitcoin as an electronic cash system built entirely on peer-to-peer technology, one that lets an online payment go straight from one party to another without passing through any financial institution.

Before 2013, Bitcoin was in hiding. This was the stage when clever money went in. Most of the people who came in then were insiders: some understood blockchain, handled mining tools well and saw the investment in it; others joined because they believed in Nakamoto's ideas. Through that period a bitcoin never cost more than $30.

From 2013 to 2016 came the waking-up stage, when institutions arrived. Big bitcoin funds appeared, more and more exchanges supported bitcoin trading, and more and more companies agreed to take bitcoin as payment for services. At the start of 2013 a bitcoin was still worth less than $30; the first sharp rise and the first dumping both happened that year.

Across 2013, Bitcoin rose about 9,205%, from $13.30 to a December peak of $1,237.60. Selling and falling prices followed at once. Then came a two-year slide. By the end of 2015 a bitcoin was down to $200. On the bubble curve this stretch is called the "bear trap."

But this was also when Bitcoin became widely known. Microsoft, Steam, Dell and other companies began accepting bitcoin payments. By September 2016 there were 771 bitcoin ATMs in the world.

By 2016 there were dozens of bitcoin exchanges worldwide, which let people who could not make sense of things like bitcoin addresses trade the currency anyway. Trading inside China at one point made up more than 80% of global volume. In December 2016, Bitcoin passed $1,000 again.

That was the start of the frenzy. Bitcoin went from $909 at the beginning of 2017 to $19,650 in December 2017 — up 2,061% in a year.

In the end what moved Bitcoin's value was not technology but greed and fear, the human instincts

Once the frenzy arrived, some investors warned about it.

Warren Buffett has been firm in rejecting Bitcoin. "I can say almost with certainty that they will come to a bad ending, but when it happens, or how, I don't know," he told CNBC in January this year. "We don't own any bitcoin, we're not short any, we'll never have a position in it. I already have enough to deal with in the things I do understand — why would I go long or short something I don't?"

In May, after the shaky decline of the first half of the year, bitcoin stood at $9,000. That was half its peak, but plenty of people still found it attractive. Buffett spoke up again to say he did not think much of the asset. He compared Bitcoin to gold and said the two share the same defect. First, both are non-productive assets. Gold cannot turn itself into more gold, or into anything else of value, whereas buying an oil field yields oil, buying a factory yields goods, and buying shares yields dividends.

Second, like gold, Bitcoin has little practical use. Gold can at least be worked into jewelry or put to a few other uses, and even that is not enough to support broad demand. Bitcoin can be used for transactions, but it settles far more slowly than mobile payment methods cleared through central banks, such as Apple Pay or Alipay. Apart from the particular needs of the grey and black markets, which want transactions hidden, it has almost no transactional value for ordinary people.

Buffett does not invest in gold, so he will not invest in Bitcoin. He called it a speculative "Buck Rogers" phenomenon, in which every purchase and sale rests on the buyer's own guess about which way the price will go — exactly like the tulip bubble of old.

Buffett's longtime partner, Berkshire Hathaway vice chairman Charlie Munger, was blunter: "The Bitcoin craze is especially stupid. I never for a second considered investing in bitcoin. I disliked it the moment it appeared. The hotter it gets, the more I dislike it."

"I may dislike cryptocurrency even more than Buffett does. Bitcoin and the other cryptocurrencies are bubbles. To me it is dementia. It feels like other people are trading turds and you rush over to join in," Munger said.

Besides Buffett and Munger, Microsoft founder Bill Gates, the economists Nouriel Roubini and Robert Shiller, and many well-known fund managers all oppose Bitcoin.

But the opinions of the people with the loudest voices in traditional finance have not become the mainstream view in the Bitcoin world. Both camps — the one that says Bitcoin is worthless and the one that says it has value — have picked up powerful supporters, and neither has won the argument.

JPMorgan CEO Jamie Dimon is a classic case of someone defecting from one camp to the other. In September 2017 he said "Bitcoin is a fraud" and that he would fire any employee who traded it, for two reasons: "one, it's against our rules; two, it's stupid." Soon afterward it emerged that JPMorgan was itself investing in bitcoin, and four months later Dimon changed his own tune, saying it was hard to say how much Bitcoin itself is worth but that the blockchain behind it has real uses.

The crash at the start of 2018 had many people looking to buy the bottom, among them Peter Thiel, the author of Zero to One and a co-founder of PayPal. Thiel has an unusual eye as an investor: he not only saw that Facebook would make billions but also bet correctly on Trump's election. His view is in fact a little like Buffett's — he too compares Bitcoin to gold, except that he thinks gold is worth investing in. "I'm skeptical of most virtual currencies, but I think a lot of people haven't understood the value of Bitcoin. To be specific, Bitcoin is more like gold: it's a store of value, not a means of payment. If Bitcoin ends up as a digital version of gold, there's a lot of room to develop it."

Bitcoin is always compared to gold because, like gold, it is scarce and limited in quantity. Twenty-one million coins: that is the frame Nakamoto set at the beginning. Bitcoin's supporters often bring up the number as proof that the coin is worth collecting.

Munger had already answered that: "Believe me, human beings absolutely have the ability to create more bitcoin. When they tell you there are rules that make it impossible, don't believe them. When the incentive is strong enough, bad things happen."

Bad things did happen. On August 1, 2017, Bitcoin Cash (BCash) became the first hard fork of the Bitcoin blockchain. A fork is like starting up a printing press: it gives people who already hold bitcoin a supply of the forked coin, and with it a brand-new digital currency to trade for profit.

After that, forking got out of hand. There is Bitcoin Candy, Bitcoin Pizza, Bitcoin God, Bitcoin Faith, Bitcoin Diamond, Bitcoin Gold, Bitcoin Atom and more.

In May this year a study by BitMEX Research reported that since August 2017 the Bitcoin blockchain alone had produced 44 forks. In other words, Bitcoin has thrown off at least 44 copies of itself. Four of them had 24-hour trading volumes above $100,000: Bitcoin Cash, Bitcoin Diamond, Bitcoin Gold and Bitcoin Private. Bitcoin derivatives that break Bitcoin's own limits had arrived.

In an ideal world the point of a fork is to improve the technology on an existing blockchain. That is not what happens. Coinomi CEO George Kimionis put it this way: "Unfortunately, the great majority of Bitcoin-based hard-fork projects we see today exist only to make money. A few years from now we may realize that rising cryptocurrency prices blinded investors, and that these projects never made a serious contribution to the cryptocurrency ecosystem."

By this point in the story the Bitcoin world was full of speculators. The Financial Times defines an investor as someone who holds coins for more than a year and a speculator as someone who sells within a year. Its data showed that in November 2017 investors outnumbered speculators about three to one; by April 2018 the two sides held roughly equal amounts — investors 6 million coins, speculators 5.1 million.

And the Financial Times measured bitcoin wallets, so its conclusion leaves out everyone trading on exchanges. The real share of quick in-and-out trading is much higher.

Most of the early supporters of Nakamoto, who mined tens of thousands of bitcoins without effort, have already left. Bitcointalk's count shows that four years ago 70 addresses worldwide held more than 100,000 bitcoins each, 3.6 million coins in all. Only 5 addresses still hold more than 100,000, close to 570,000 coins between them. The accounts that held large amounts early have cashed out over the past few years, and the crowd that poured in afterward was left holding the coins — which is the crash we have watched this year.

Other cryptocurrencies have crashed the same way, and raising money by issuing a cryptocurrency has mostly turned out to be an even quicker bubble, or plainly a swindle. A survey of 2017's ICO projects by the crypto news site Bitcoin.com found that of the 902 ICO projects tracked by TokenData, 142 failed before they finished raising money and another 276 failed after. That puts last year's ICO failure rate at 46%. Bitcoin.com also pointed out that another 113 projects were half-failed: either their teams had gone silent or their communities were barely alive. Count those and the failure rate rises to 59%. Bitcoin.com estimates that these failed 2017 ICO projects harvested $233 million in cash altogether.

With prices swinging this violently, Bitcoin's value as a currency for transactions is gone

Earlier on, Bitcoin's champions really did try to bring it into the economy as a currency. In 2016 Japan's cabinet recognized virtual currencies like Bitcoin as a means of payment equal to real money. The gaming platform Steam announced support for bitcoin payments soon after. In July of that year, after Argentina's government blocked credit cards, Uber started taking bitcoin payments there.

But the institutions that announced support for bitcoin payments were not really trading in bitcoin. The coins had to be converted into ordinary money through a third-party bitcoin payment service first.

Say you want to buy a laptop on Dell's site with Bitcoin. Here is what happens behind the screen: the buyer orders a $1,000 laptop and chooses to pay in bitcoin; Coinbase, the third-party bitcoin payment service, converts the purchase into about a third of a bitcoin at the current rate; the buyer pays Coinbase in bitcoin, and Dell receives dollars. From beginning to end, Dell never takes any bitcoin.

In fact many companies that once said they would accept bitcoin, Dell among them, dropped it over the following years. For them, handling a bitcoin transaction was too much trouble, and every transfer took about ten minutes to go through, which is no one's idea of efficient. More important, Bitcoin's price moved more and more violently, until it was no longer fit to use as a currency.

Put it this way: at the start of this year, with the price around $10,000, someone holding ten bitcoins could buy a luxury sports car. Half a year later, in China, the same ten coins would buy a mid-size sedan. This is a high-risk investment, not a currency most people want to keep their life savings in.

Ten years on, Bitcoin has gathered a great deal of wealth and a great deal of argument, and for all the new cryptocurrencies born after it, it changed how people think about digital money.

The blockchain system Nakamoto defined for Bitcoin ten years ago is still in use. The cryptocurrencies that came later compute more sensibly and have more complete systems, and not one of them has surpassed it.

The software industry rarely produces something ten years ahead of the world; Bitcoin showed rare foresight. But the goal Nakamoto imagined — keeping property safe for ordinary people — was never reached. As more and more people speculate on it as an investment, it drifts further from being a currency. Even if its blockchain database finds more uses later, that will not change what Bitcoin itself is worth as an object of speculation.

Ten years after it was born, the meaning of Bitcoin's existence remains, like the identity of Satoshi Nakamoto, a mystery.

Cover image/visualhunt