Bitcoin’s Worth: Liquidity, Volatility and (Least of All) Value.

In the short time that Bitcoin has existed the amount of press, controversy and debate that it’s managed to stir up has been quite staggering. Back at its inception many jumped on it as a way to make a few bucks on the side without having to actively participate in anything but it soon quickly grew from there into a stable little economy that had a mix of both wealth seekers and believers in the idea. The start of this year saw Bitcoin undergo a massive meteoric rise to fame, drawing the critical eye of economists and arm chair financials like myself. The speculative bubble soon burst sending millions of imaginary worth into the digital ether and the confidence in the currency was shaken. Still I saw this as a Bitcoin coming of age as if it could survive this it could potentially become the currency everyone was hoping it to be, once it had some stability.

Since then it appears that the Bitcoin market had hit the bottom of the bursting bubble, tapping out around the US$2 range. It’s since then recovered a little more to be around the US$4 range which, whilst still not being the dizzying heights we saw back in June, is still quite respectable and lot higher than it’s value in years past. What’s truly interesting however is Bitcoin’s transaction volume over the past couple months, it’s actually remained quite high:

Looking at that graph you can draw the conclusion that whilst the value of a Bitcoin has dropped significantly it’s actually still seeing quite a lot of use as a transactional currency. The trading volumes of some of the days in recent months dwarfs that of the speculative bubble and yet the Bitcoin price has remained somewhat steady. This graph would then indicate that the speculators which drove the bubble to it’s crazy highs have well and truly left the market and the majority of currency conversions are from people actively using it as a commodity rather than an investment.

This was one of the biggest challenges facing Bitcoin: it’s liquidity with other currencies. Whilst it’s all well and good to think that we could do all our transactions in this new medium the fact is we can’t and thus Bitcoin’s utility is directly linked with our ability to exchange it for real world currencies. Indeed Ars Technica gives a good view on how Bitcoin’s could market itself as a better wire transfer service and this new found liquidity definitely plays a part in making such an idea come into reality. There is one nagging problem however and that’s the underlying volatility of a commodity with such a small trade volume.

The chart above would lead you to believe that the Bitcoin price had been relatively stable for the past 2 months but that’s just a function of how the graph is presented. Instead of showing the daily average price and transaction volume over the past year if we instead take hourly price and transaction volumes we see a very different picture:

What we can see here is just how volatile the value of the price really is. Whilst it’s nothing compare to the speculative bubble you can still see that transaction volumes on the order of 20K to 40K can swing the price of a Bitcoin considerably, on the order of US$1 or more. Granted there does appear to be periods of low transaction volume with steady growth (between the 17th of November and 1st of December) but the only time that Bitcoin enjoys true value stability is when the transaction volumes are below 10K per hour, and that’s got to change if Bitcoin can be considered as a stable currency. Right now anyone with $120,000 could swing the market one way or another, which is chump change for almost any investment firm.

The takeaway from all this then is that whilst Bitcoin has definitely taken a step forward in terms of liquidity it’s still far too volatile to be considered as a good transactional currency. Whilst I believe the actual value of a Bitcoin is largely irrelevant what does matter is how stable it’s value is over a long period of time. Right now Bitcoin still has the same inherent instability that allowed speculators to create the huge bubble back in June and until it manages to stabilize itself I can’t see getting past the technical novel stage. Whether it’s capable of doing this I can’t comment on as whilst it’s a technically elegant solution economically the challenges it faces are quite large and I’m not sure they have a simple solution.

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