Bitcoin was trading at $1,000 at the beginning of December 2013; It dropped below $400 on last Thursday. The pessimists are telling us that Bitcoin has dropped by 62% in four and a half months, but realists are telling us that the value went from $93 in April 2013 to $398 in April this year, a 428% increase. When Bitcoin was trading at 1K the people buying it were investors, rather than advocates. The coin was bought with the intention of selling at a profit rather than purchasing an item, or items, using the currency. What we saw, late last year, was clearly a speculative bubble; what we’re seeing now is simply value price reality. When the value was high, any purchases made would have involved small transaction sizes; and this had the potential to drastically slow the speed of transaction confirmation. Therefore at high bitcoin values, numerous small transactions are rendered all transactions unwieldy and slow, and this potentially causes a huge long-term problem.
Bitcoin is primarily a currency, any function it holds as a store of value, or investment, must be secondary to this. We can not expect bitcoins to be widely adopted and spent until a large portion of the 76% of people who know nothing about it, decide to come on board. To achieve this Bitcoin needs to stabilise. To achieve stability Bitcoin needs to improve the volume of transactions. The solution is simple; small number of transactions lead to value volatility but larger volumes will act to stabilise the value. If stability is achieved, more and more people will move to come on board.
The problem with Bitcoin value is simply that we know what its value is in relation to fiat currency. We do not know, however, what the value of the fiat currency is. If a barrel of oil costs, for example, $60 and the price of oil goes up to $70, what effect does that have on the dollar? Well, if prices go up by 10% across the board, then we know the value of a dollar has dropped by 10%. But here is the problem… what is a 10% devalued dollar worth? 90 cents? No, it’s not, we don’t think like that unfortunately. The devalued dollar is still seen to be worth a dollar and prices are seen to have risen. We call it inflation. Now let’s look at Bitcoin in light of the devalued dollar. Bitcoin selling at $400 yesterday is trading at $440 today, and we say that Bitcoin has gone up. Bitcoin is a volatile currency because we peg it to the dollar, or the euro or the yen, and do not take the fiat inherent volatility into account. To truly assess the value of bitcoin we should measure what a single bitcoin can purchase rather than how many dollars would buy one. Perhaps, this could be achieved through the use of an aggregate price index, a typical shopping basket, so to speak. This is the very same tool that economists use to assess inflation. They look at domestic spending, develop a list of expenditures and monitor changes in that list of weighted expenditures.
We are currently seeing the beginnings of a recovery in the price of Bitcoin; We must be aware that many people will crowd the exchanges in an attempt to get on board. These are the very investors that will rush to exit Bitcoin at the first sign of a fall in value. These ‘Low Tech’ investors, with their flock like behavior, have the capacity to cause a bubble as well as the capacity to burst one. Now that Bitcoin has stabilized somewhat, and we know that Wall Street is paying attention in the wings, we must be careful of the volatility that low tech investors will bring. Bear in mind, however, the effects of these investors will generally only be short term, In the medium term the sheep will always depart… the incoming wolves may not.
Last modified (UTC): April 15, 2014 09:33