Posted by: Dirk | November 28, 2018

Will the price of Bitcoin fall to zero?

Much has been written about Bitcoin, and the recent loss in price (in USD) has led investors to ask where this will all end. As an economist, I would say that it is quite likely that the price of Bitcoin will be zero.

When a currency – which Bitcoin is not – experiences a fall in the exchange rate to the USD, there is usually some demand for it at a lower price. Economic units with debt in that currency and assets that are denominated in others find it profitable to pay off debt while the exchange rate is low. This is what normally stops the decline of hard currencies. Speculation about this can dampen the over- and undershooting that we see with softer currencies, but it is roughly the same game.

The price level can react to the exchange rate, but normally prices are set in domestic currency. Therefore, changes in the exchange rate do not influence domestic prices much. This is an empirical fact, as the up and downs of the oil price in the last twenty years did not cause wage rates and prices to follow along.

Now, Bitcoin is different. When the price of Bitcoin falls, everything will be more expensive in terms of Bitcoin. Changes in the price of Bitcoin are translated into inflation one to one. With Bitcoins price falling, people holding Bitcoins and using them to buy things will experience hyperinflation. They need more Bitcoins to pay for the same basket of goods every day. This is not a nice feature. Where does this end?

If there are no debts denominated in Bitcoin, then it is obvious that the price of Bitcoin shall be driven to zero. Once the ship starts sinking – the price of Bitcoin goes down – it becomes clear that there is no stabilizing demand, like with currencies. Nobody is forced to use Bitcoin for tax payments either, as with normal currencies. Once Bitcoin goes down, expectations will be that it goes down further. Who would want to hold an asset with a declining price and no reasonable theory of why it should go up in price?

The price of Bitcoin should fall to zero. When, nobody knows.

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