Bitcoin has been in the news a lot lately and I’ve finally got into the game with a small investment to play with.

Bitcoin is a new form of currency  which is technically quite ingenius but from an economic standpoint is quite unstable.  It’s basically a digital, anonymous, peer supported replacement of cash.  Each transaction is confirmed by others participating in the bitcoin network so that fraudulent coins are not spent, and money isn’t spent twice.

The value of each bitcoin has soared over the last 2 months from $30 to over $200 per bitcoin.

The way new bitcoins are created is through an algorithm called ‘mining’.  It’s designed to grow the number of coins linearly regardless of how much computer power is mining or how many are being used.

This is ultimately the biggest problem with the currency.  Lack of control over the supply means that the price of it is dependant on demand on currency exchanges.  The price of a bitcoin is skyrocketing because recent news coverage has created an exponential increase in people wanting to buy some while the supply of new coins can’t meet that demand.

Markets are fickle things, especially when untrained non-sophisticated traders are working the markets.  Quick emotional reactions will at some point result in a crash.

If you were using bitcoins right now to do business you’d be having massive deflation effects.  The value of the bitcoins you have would be going up and therefore anything with a fixed price is becoming more expensive in hard currency.  If you were paying your employees in bitcoin then over the last 2 months your business expenses would have increased by 7x.

In Canada the Bank of Canada’s main job is to manage inflation.  Steady inflation is what allows us take loans and expect to be able to pay them off, to hire workers at a set wage, to set product prices and have them maintain the same price day to day.  The controls over inflation don’t exist in bitcoin so the risk is quite high.

I’m not sure where it will go in the future.  Will bitcoins hit $1000 each?  it’s possible. $10,000? maybe.  It will for sure be a bumpy road though.