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Bitcoin slump follows senators’ threats

Correlation or causation?

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As any investment adviser will tell you, it’s a bad idea to put all your eggs in one basket. And if Rick Falkvinge was telling the truth when he said all his savings were now in Bitcoin, he’s been taken down by a third in a day.

Following last week’s call by US senators for an investigation into virtual crypto-currency Bitcoin, its value is slumping.

According to DailyTech, Bitcoins last Friday suffered more than 30 percent depreciation in value – a considerable fall given that the currency’s architecture is designed to inflate its value over time.

The slump could reflect a change in attitude among holders of Bitcoins: if the currency were to become less attractive to pay for illegal drugs, then dealers and their customers would dump their Bitcoins in favour of some other medium.

Being dumped by PayPal won’t have helped either. As DailyTech pointed out, PayPal has a policy against virtual currencies, so by enforcing the policy, PayPal has made it harder to trade Bitcoins.

The threat of regulation may also have sent shivers down Bitcoin-holders’ spines. The easiest regulatory action – although requiring international cooperation – would be to regulate, shut down or tax Bitcoin exchanges such as the now-famous Mt Gox. However, a sufficient slump may well have the same effect as a crackdown: whether Mt Gox is a single speculator or a group of traders, it’s unlikely to have the kind of backing (or even, perhaps, the hedging) that enables “real” currency traders to survive sharp swings in value.

The collapse does, however, highlight a weak point in a model to which some pundits have assigned messianic status. Its algorithm is designed to manage Bitcoin supply, causing a diminishing issuance of new Bitcoins over time (or, to be more precise, making it harder over time to "mine" new Bitcoins).

However, this only manages a self-contained system. If people want, at any time, to exchange Bitcoins for “real” dollars, then their value also depends on their relationship to those dollars – making Bitcoins hostage to market sentiment.

That sentiment seems to be collapsing at the moment. This may not mean the end for Bitcoin – but if its exchanges start falling over, then it will be the end of a carefree, idealistic life for the virtual currency. ®

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