BitInstant, BitCoin Market Corrections and Cryptocurrency’s Future.

There seems to be a prevailing idea that the price of BitCoins is somehow intrinsically linked to the overall confidence in the use of the nascent cryptocurrency. If you’ve read any of my previous articles on BitCoin you’ll know that I strongly believe that that isn’t the case and indeed a rising price is usually a signal of speculative investors gaming the market to turn a quick profit more than it being an indication of market confidence. Indeed I was most bullish on the idea of BitCoin when its price  stop fluctuating which meant it was far less risky for people to use it as a wealth transfer vehicle, especially for those who are taking the risk of using them in their business.

Now I’ll be completely honest here, when I saw the first stirrings of an upward tick in BitCoin’s price I wasn’t too worried that it would lead to a speculative bubble. Sure it was dangerously close to the same ramp up just a year previous but I felt that the higher transaction volume, larger amount of wealth contained in the BitCoin network and hopefully the market’s long term memory would ensure that any growth in the price was purely organic and sustainable. Of course this discounted external actors with larger amounts of capital working to skew the market in order to turn a profit but I felt that the speculators had had their fun last year and had moved onto other, more lucrative endeavours.

Looks like I was wrong.

As you can see from the above graph the BitCoin price took a turn for the volatile side around the middle of July. Since then there’s been several spikes in trading volume most of which have coincided with a jump in the price. Whilst there appears to be islands of stability that last about a week it never lasted long before another trading bout would push the price upwards. This culminated in a peak price of about $14 late last week quickly followed by a swift downward correction in price with it stabilizing around the $10 mark. As I’ve said before this kind of price volatility is very much at odds with BitCoin being a proper currency and it’s unfortunate to see history repeating itself here again.

Interestingly though the correction in price may actually be due to dwindling confidence, but not in the BitCoin idea itself. The first lawsuit involving BitCoins and the failed wallet service Bitcoinica was lodged just days prior to the value taking a swift nose dive. This was most likely exacerbated by people attempting to cash out at the current peak as you can see the transaction volume on that day was several times higher than the average for the preceding couple of months. Bitcoinica, unfortunately, isn’t the only story of BitCoin based services that have endured failure and this could have very easily shaken the market enough to attempt to dump out early to avoid losing all their value.

The underlying cause to much of the volatility that the BitCoin market experiences is the relatively small amount of value that it captures. Whilst as a whole the BitCoin market is valued at some $97 million (total number of BitCoins in existence multiplied by current price) the total transaction volume on any given day usually only averages $800,000. That’s incredibly open to manipulation and showcases just how crazy those peak trading days, the ones where the value changing hands is on the order of 3 times the average, really are.

Now I don’t pretend to have a solution to this but a new startup called BitInstant might have the right idea when it comes to injecting more value into the market and hence (hopefully) reducing its volatility.

BitInstant is a clever little idea using prepaid MasterCard debit cards which are then backed with either real US currency or BitCoins. The cards can be recharged either by traditional means or by using a BitCoin address that’s printed on the back of the card. They make this even easier by also including a QR code on the back which would enable users to transfer BitCoins between them using things like BitCoin enabled apps on their smart phones. The details on it are still being finalized but this has the potential to take BitCoins from their current niche operations to a much larger scale and hopefully with that bring a lot more stability to the BitCoin price.

BitCoin purists will probably detest the cards since they will require some level of formal identification for them to be able to use it, thus eliminating the benefits of anonymity, but I don’t believe BitInstant’s product is aimed at them. Indeed it seems to be more of a way to make BitCoin function more like a traditional currency as currently it really is only for the technical elite or those who have a need to transfer funds in a completely untraceable manner. Giving people a physical card they can use anywhere will go a long way to making BitCoins much more palatable for the masses, something that all the current BitCoin services I feel have failed to do.

BitInstant is just one piece in the larger puzzle though and realistically its going to take many, many BitCoin enabled services to make it viable as a currency. Good news is that appears to be happening with BitInstant being just the latest contender to throw their hat into the BitCoin ring. Hopefully this means that the peaks and troughs in BitCoin’s trading price will soon be a lot more tame and then I’ll stop harping on about how BitCoin’s price is the last thing we should be thinking about if we’re serious about it being a currency.

21 Comments

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  1. Ah thanks, I’ll correct the mistake in the post.

    It’s a bit of back of the envelope math using what appears to be the average transaction volume on Mt.Gox multiplied by the current price of about $10. This is certainly not reflective of the amount of transactions that take place globally between users or through other exchanges so it’s not surprising that the total transaction amount would be a lot higher. Indeed from what I’ve read the vast majority of actions are pure BitCoin transactions between users which would explain the discrepancy.

    Really all I was trying to highlight with that statistic is just how small the volume of exchange is, which is what leads to the volatility that we see. Whilst pure BitCoin transactions might account for a much larger amount of wealth transfer than exchanges do it unfortunately isn’t reflected in the exchange rate. BitInstant and other glue services between BitCoin and real currencies will help to make the exchange rate much more stable and will in turn increase the rate of pure BitCoin transactions.

    Thanks for your insights and link, I hope that helps clarify my position.

  2. Correction.

    > BitInstant is a clever little idea using prepaid MasterCard credit cards

    Their Paycard is a debit card.

  3. You should check out what is happening with pirateat40s ponzi scheme. The drop happened 10 minutes after he said he was stopping the plan (which many believe to be an investment scheme). Some thing pirate might be selling a large amount of bitcoins onto the market (rumor is he has 500k – I am not sure if this number is correct but the min. estimate is 100k BTC) in an effort to manipulate the market for his own gain. I think this is a great post but it misses the importance of what is going on with the BTCST (the ironically named BTC Savings and Trust).

  4. Interesting I hadn’t heard about pirateat40’s scheme and you seem to be bang on with labelling it as a ponzi scheme. The dip then could be very well attributable to him dumping an incredible amount of currency on the exchanges in a short period of time (indeed the transaction volume spiked heavily in those days, so it’s not implausible) and you could possibly trace it back to him if you knew what addresses he was using. I’ll have to keep my eye on this and it does have the potential to have some short to medium term impacts on the BitCoin economy.

    We could verify this if we had someone had some records of the blocks that they sent to him. Has anyone done any further investigation to see if he is dumping those coins?

  5. @Anonymous
    Seems I made an error in the quick calculation I did. 80K transactions @ $10 a pop is actually $800,000 not $80,000 like I say in the article. Correcting for that it’s actually a lot closer to reality. Mutliplying that out to a full month gets us a much more accurate number.

    My analysis still holds though, that value is low enough for any kind of capital firm could manipulate the whole market without fear of losing much. Hell that kind of money could easily be written off as trading loses for a single day and no one would bat an eye at it.

    Although taken under consideration of the current BTCST debacle that’s under way however pirateat40 could easily be using his stash of BitCoins to manipulate the market at the current transaction volume levels.

  6. Will you be able to pay in bitcoin using the card? I.e. you can load it with either USD or BTC but the merchant you are paying, can they receive BTC & not USD or other fiat? That would be the best thing because there will be less need to exit the bitcoin ecosystem and it would be easier for merchants to accept. Also, in the event that you need to exit BTC & get USD, it can be done instantaneously. Hopefully the fees will be low.

  7. From what I’ve read you can use it just like a regular prepaid debit card but you can recharge it with BitCoins if you so desire. They’ll handle all the currency conversion on the back end so I believe the merchants will receive US dollars. Unfortunately it doesn’t look like you’ll get the choice of giving them BitCoins using the card however.

    The fees do look pretty low, on the order of 1% to recharge (that was lower than I remember it being on some of the cards I looked into when I was travelling).

    It might be possible to do something like you describe using NFC with something like Google Wallet and a BitCoin aware point of sale system. I’m sure there’s already solutions available for that too, they just won’t be particularly common yet.

  8. @Charles Bitcoiner

    I think the problem this card is addressing is spending bitcoins you have received. If you are limited to spending in bitcoin form, at present you have a limited range of things to spend it on. If you can auto-convert to dollars, you widen the range of spending options dramatically. This in turn makes it more acceptable for individuals to take bitcoins as income/payment, which will grow the bitcoin ecosystem.

  9. If you didn’t see that as being a bubble from the start you were woefully deluding yourself. Seemed pretty obvious to anyone who isn’t religious.

  10. Don’t you think bitcoin is much more evolved, tested and secure than any other cryptocurrency? That’s why it has so high price. Don’t you think so?

  11. @lol
    You need to get better at trolling, son.

    @micolin
    Whilst BitCoin is the most advanced cryptocurrency around that doesn’t necessarily mean it should attract a high price. Indeed if BitCoin’s aim is to be simply a vessel for transferring wealth then its exchange rate is actually the least important aspect of it. Price stability is far more important in that case and that can only come with higher transaction volumes and more wealth injected into the BitCoin economy.

    Now over time a BitCoin’s value will have to trend upwards as we get closer and closer to the upper limit and fractional trading becomes more common. We’re no where near that point yet, there’s still some 12 million coins left to be mined out there, so right now an inflated BitCoin price really doesn’t help any body. The most desirable thing for BitCoin right now would be another steady state period like we had in the lull between the last two periods of volatility.

  12. @David Klemke
    Pirate’s BTCST may explain the recent upward trend as well as the crash. From messages on bitcointalk.com, one might infer that a significant number of people were exchanging fiat for BTC in order to get into the BTCST plan. This plan was paying 7% per week. That sort of return is a pretty powerful incentive for acquiring BTC.

    Upon closing BTCST, the market indeed took a dive. This may be partly due to Pirate cashing out BTC (though I’ve seen no evidence to suggest this), but also due to less demand for BTC, as there was no longer a plan paying such high returns. Not to mention the psychological effect of BTCST perhaps turning out to be a ponzi scheme.

    Last I heard, Pirate was going to take about a week to shut down the claimed dollar-denominated side of his program, then pay everyone their principal and accrued interest. That was about a half-week ago. We really don’t yet know definitively whether or not it was indeed a ponzi that he was running.

  13. @Krell Karu
    It most certainly could have been, when was the start date of this particular scheme? The initial ramp up didn’t appear to be from excessive transactions but the big jumps definitely coincided with what appeared to be a rush for BTCs on particular days. How people expected a 7% return per week to be sustainable is beyond me however, but I won’t argue that people would have found those numbers highly attractive.

    Agreed that there’s no evidence to support Pirate cashing out his BTC so it could very well be just the market’s reaction to BTCST closing down. From what I’ve read small payments have started to trickle out from a mining pool that Pirate was involved with so there does appear to be some indication that he might pay everyone back (although if that’s with the promised returns remains to be seen).

    Personally I would’ve been pretty wary of something promising returns of that magnitude as that’s the kind of annual return that most traditional investments struggle to achieve. Granted high risk scenarios do sometimes pay off (and that might have been how it was marketed) so there might have been some legitimacy to the scheme. If you have some links to the original BTCST proposition I’d be glad to have a look at them to see how it stacks up as I haven’t been able to dredge up much thanks to the recent controversy.

  14. Sorry for another post so soon but it was interesting pirate also ran a program called GPUMAX. I believe it paid 120% of a mined coins value. Mined coins are clean in that they have no transaction history, so a theory was that he was laundering money and was using the newly mined coins to pay off people with “dirty” coins. Then the dirty coins paid the miners. But there are already laundry services which charge much less than 20%! So perhaps this was to entice people into thinking the huge returns were due to some black market activity. Like we saw with Madoff, some people invested even though they knew something wrong was going on – they just wanted to perhaps benefit from Madoff’s ability to front run the his firm’s brokerage clients!

  15. Thanks for coming back James, that’s certainly starting to shed some more light on the matter. Seems like the GPUMAX service was a pretty nifty little service (being able to monitor your miners remotely and being able to rent yourself out to GPUMAX’s clients for extra income) and following the bouncing ball led me to find the original business plan. I personally wouldn’t have invested money in such a venture but then again I’m not a massive risk taker.

    Krell does have a point though that it might be worth giving pirate the benefit of the doubt until the time he allotted to resolving the matter ends. He certainly seems to be invested in the BitCoin idea pretty heavily so it’s up for debate as to whether he’d want to poison the well like some people are claiming. It’s definitely something to keep an eye on though and I’ll be watching it (and the exchange rate) quite closely over the next couple of days.

  16. Good to hear back from you David and thanks again for the post! I guess it would have made sense to mine through GPUMAX (especially if you were already mining) as you could immediately have a 20% profit on the coins. It might show how inefficient the BTC markets are at the moment though because if there was a viable service then the market should have pushed down the profit margin with time. It could have even been possible to set up some type of arbitrage and do the BTC equivalent of picking up nickles in front of a steamroller. So something strange is definitely going on.

    Right now there is a respected forum member offering up to 10K BTC in bets. He offers 100% ROI to anyone if pirate does pay back. So people who don’t think pirate will pay back are able to place wagers (in escrow if desired) with him. I think he is giving pirate 3 weeks. Right now pirate will be famous either for running a massive ponzi… or for running the most profitable investment in world history! Occam’s razor leads me to reject the notion that “this time is different” but I haven’t (yet) placed a bet.

    If I might speculate a bit: I think pirate is trying to drive the market down so that he can buy back bitcoins on the cheap. It’s his only hope if the ponzi has gotten out of control and he wants to try and pay it back. He would like people to think he is in control of the market. Things have been stable for the last 3 days. But I don’t think he has many BTC left to sell. All we can do now is wait and see what happens.

    Also interesting to the price is the block reward halving to 25 in late November/early December, plus the introduction of ASICs later this year. Butterfly Labs now has some competition – interestingly enough the company funded itself by selling shares on the GLBSE.

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