Beware of the Bitcoin Economy Bust
A belief held by a large portion of the Bitcoin community maintains that our beloved digital currency is recession proof. Bitcoin is based on the principles of sound money; the currency possesses scarcity, portability, fungibility, and infinite divisibility. Most importantly, Bitcoin’s scarcity makes it impossible to inflate the supply, which many Bitcoiners believe to be […]
A belief held by a large portion of the Bitcoin community maintains that our beloved digital currency is recession proof. Bitcoin is based on the principles of sound money; the currency possesses scarcity, portability, fungibility, and infinite divisibility. Most importantly, Bitcoin’s scarcity makes it impossible to inflate the supply, which many Bitcoiners believe to be the source of financial instability and economic recessions.
Economic theory supports this notion, although most of the corroborating theories come from heterodox schools of thought and are not accepted by the mainstream. According to the Austrians, Inflating the money supply “artificially” lowers interest rates, which sends false information to entrepreneurs. These businessmen then embark upon projects that are not truly profitable given the actual market data, and must ultimately end unsuccessfully. This process is known as the business cycle, and it has plagued society since the dawn of the market economy.
Bitcoin Against the World
If this theory proves to be true, sound money alternatives like Bitcoin or precious metals would be viable alternatives to inflated fiat currency. Their scarcity prevents them from being printed “out of thin air,” which in turn makes it impossible to “artificially” lower interest rates. Consequently, entrepreneurs only receive accurate information signals, and resources are not mis-allocated in such a way as to cause a market-wide downturn.
Under this business cycle theory, Bitcoin would indeed stand a fair chance of being recession proof. However, in order for that to happen, Bitcoin must survive in somewhat of a vacuum, in which it is the global currency of choice and there are no fiat currencies operating alongside it.
Of course, we know that Bitcoin exists in anything but a vacuum, and it must operate in an economy dominated by multiple fiat currencies — all of which are controlled by central banks through monetary policy. Furthermore, as far as Bitcoin companies are financed through institutions touched by inflation-affected interest rates, the Bitcoin economy can become the victim of the business cycle. Thus, Bitcoin is in very close proximity to an unstable economy rife with recessions and downturns, and it is far from immune.
To reiterate, the entire Bitcoin economy, the industry that sprouted up in response to the growth in digital currency awareness, is susceptible to the business cycle. This means that cryptocurrency exchanges, Bitcoin-exclusive companies, Bitcoin remittance services, Bitcoin news websites, and any other Bitcoin-driven company may in fact be part of a boom phase that is sure to go bust.
But is it really likely that inflation has seeped into the Bitcoin community from fiat-based investments in Bitcoin companies? While nothing theoretically prevents the Bitcoin economy from entering a cycle of boom and bust, it seems unlikely at this point in time that our fledgling industry has pulled in enough mainstream investors to bring in a significant amount of mis-allocated capital. So, right now, there probably isn’t much to worry about. However, as Bitcoin’s popularity grows, so too will investors’ interest in Bitcoin-powered companies, which will bring in the boom-and-bust-producing inflation.
A Shot in the Dark
Unfortunately, while I don’t think there is a significant chance of a Bitcoin business cycle occurring at this point in time, the truth is that it is hard to know for sure. One of the unfortunate parts about the malinvestment theory of the business cycle is that its logical conclusion entails an inherent uncertainty in the credit structure. There is no way of knowing with certainty whether or not an investment has happened due to artificially low interest rates, or if it is a healthy venture that would have been successful even in the absence of credit expansion. Thus, theoretically, the entire industry could fall down around us with very little warning.
On the bright side, the Bitcoin economy is inundated with entrepreneurs who adhere to this circulation credit theory of the cycle — or are at least sympathetic to its teachings. Therefore, we are fortunate to have business leaders that could make active attempts to avoid the pitfalls of malinvestment, being extra careful in their ventures. Entrepreneurs like Roger Ver — who got this website off the ground out of pocket — have the ability to preemptively avoid debt-based financing if possible, hopefully shielding our growing industry from the business cycle.
As the Bitcoin economy becomes more mainstream, however, traditional finance will begin to play more of a role in startup funding. This means an increase in the presence of bank credit and other traditional, debt-based instruments that are driven by credit expansion. The best way to prevent this from happening is to encourage unyielding economic awareness and education, which will ideally foster financial responsibility and prudence. By following these practices, we may be able to keep inflation out of our economy for as long as possible, giving it a solid base of strength and development that will allow it to whether business cycles if and when they hit us.
The Bitcoin economy is far from recession proof, and it can collapse just like any other market. We have a unique opportunity, though, to employ our shared theories and ideologies to keep Bitcoin true to its original intent for as long as possible. If we succeed in this, we can keep our digital currency alive long enough to truly flourish and grow, even if it does eventually fall victim to the trade cycle.
Do you think the Bitcoin economy is recession proof? Let us know in the comments below!
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The opinions expressed in this article are not necessarily those of Bitcoin.com.