My friend Megan McArdle thinks the Mt. Gox meltdown spells doom for Bitcoin. Henry Farrell agrees. Both contend that Bitcoin ultimately rests on the confidence of users, and the kind of public relations fiasco Bitcoin has suffered this week can shake public confidence in the currency and halt the momentum the currency needs to go truly mainstream.
This argument is plausible. In fact, it's so plausible that I made it in August 2011. After hitting a record high of $32 in June, the price had plunged to $7. I pointed out that Bitcoin didn't have any fundamental value, and I predicted that the falling price would start a vicious cycle where the falling price undermined confidence in the currency, which would push its value down even further.
There was a lot of reason to be pessimistic about Bitcoin in the summer of 2011. Mt. Gox, the leading Bitcoin exchange, had shut down for several days after hackers briefly pushed the price down to $0. A Bitcoin user said he had lost $500,000 worth of Bitcoins to another hacker. One of the most popular Bitcoin wallet services, called MyBitcoin, had just disappeared from the Web, claiming that yet another hacker had stolen customer funds.
Little wonder the price of Bitcoin fell and fell. The price fell to $2 in November. At that point, almost everyone, including me, viewed Bitcoin as a failed experiment. It was hard to imagine people buying back in at that point.
But then something surprising happened: Bitcoin's price started rising. It jumped to $4 in December and rose above $7 in January 2012.
It's hard to say exactly what inspired people to start buying again after seeing Bitcoin lose more than 90 percent of its value. But it seems that a core group of Bitcoin users had so much confidence in the technology's long-term potential that they saw $2 as a buying opportunity.
That brings us to today. Obviously the string of bad press about Bitcoin-related businesses hasn't been good for the technology's growth. But for all the negative headlines, things don't look nearly as grim as they did in late 2011. Bitcoin has a number of assets it didn't have three years ago: startups backed by millions of dollars of venture capital, the endorsement of federal regulators and lawmakers, and a dramatically larger user community.
Most importantly, Bitcoin insiders remember the events of 2011. They remember that people who panicked and sold their Bitcoins at $10 or $5 in late 2011 went on to regret it, while people who bought in at $2.50 made huge profits. And they remember that even as the price was plummeting, entrepreneurs were starting work on startups like Bitpay that would help expand the market for Bitcoins. They're not going to make the same mistake again.
That's fine, Megan might say, but Bitcoin needs to attract new users, not just hold on to the ones it already has. That's probably true. But expanding the Bitcoin community is a long-term process. Bad press hampered the growth of the Bitcoin community in late 2011, but it didn't take long for things to shake out and growth to resume in 2012.
That's because seasoned Bitcoin users understand the difference between Bitcoin as platform and individual Bitcoin companies. The failure of individual Bitcoin companies is evidence that these companies were poorly run, but it's not evidence that the Bitcoin's underlying infrastructure is defective.
In the long run, Bitcoin's success will depend on whether the Bitcoin community develops compelling applications for the cryptocurrency. If Bitcoin applications provide users with real value, they'll be able to overcome users' initial wariness about the platform. If the community fails to make Bitcoin useful to ordinary users, then it may go the way of 8-track tapes. But the failure of Mt. Gox doesn't doom Bitcoin any more than the failure of Pets.com doomed the Internet.