Posts Tagged‘bitcoin’

Bitcoin at a Crossroads.

Despite what others seem to think I’ve always liked the idea behind cryptocurrencies. A decentralized method of transferring wealth between parties, free from the influence of outside parties, has an enormous amount of value as a service. Bitcoin was the first incarnation of this idea to actually work, creating the ideas that power the proof-of-work system and the decentralized nature that was critical to its success. However the Bitcoin community and I soon parted ways as my writings on its use as a speculative investment vehicle rubbed numerous people the wrong way. It seems that the tenancy to run against the groupthink runs all the way to the top of the Bitcoin community and may ultimately spell its demise.

bitcoin-wall4

Bitcoin, for those who haven’t been following it, has recently faced a dilemma. The payment network is currently limited by the size of each “block”, basically the size of the entry in the decentralized ledger, which puts an upper limit on the number of transactions that can be processed per second. The theoretical upper limit was approximately 7 per second however further development on the blockchain meant that the upper limit was less than half that. Whilst that still sounds like a lot of transactions (~600,000/day) it’s a far cry from what regular payment institutions do. This limitation needs to be addressed as the Bitcoin network already experiences severe delays in confirming transactions and it won’t get any better as time goes on.

Some of the core Bitcoin developers proposed an extension to the core Bitcoin framework called Bitcoin XT. The fork of the original client increased the block size to 8MB and proposed to double the size every 2 years up to 10 times, making the final block size somewhere around 8GB. This would’ve helped Bitcoin overcome some of the fundamental issues it is currently facing but it wasn’t met with universal approval. The developers decided to leave it up to the community to decide as the Bitcoin XT client was still compatible with the current network. The community would vote with its hashing power and the change could happen without much further interaction.

However the idea of a split between the core developers sent ripples through the community. This has since culminated in one of the lead developers leaving the project, declaring that it has failed.

His resignation sparked a quick downturn in the Bitcoin market, seeing the price shed about 20% of its price immediately. Whilst this isn’t the death knell of Bitcoin (since it soon regained some of the lost ground) it does show why the Bitcoin XT idea was so divisive. Bitcoin, whilst structured in a decentralised manner, has become anything but that with the development of large mining pools which control the lion’s share of the Bitcoin processing market. The resistance to change has largely come from them and those with a monetary interest in Bitcoin remaining the way it is: under their control. Whilst many will still uphold it as a currency of the people the unfortunate fact is that Bitcoin is far from that now, and is in need of change.

It is here where Bitcoin finds itself at a crossroads. There’s no doubt that it will soon run up hard against its own limitations and change will have to come eventually. The question is what kind of change and whether or not it will be to the benefit of all or just the few. The core tenants which first endeared me to cryptocurrencies still hold true within Bitcoin however its current implementation and those who control its ultimate destiny seem to be at odds with them. Suffice to say Bitcoin’s future is looking just as tumultuous as its past and that’s never been one of its admirable qualities.

Dogecoin Gets It, Everyone Else Doesn’t.

Cryptocurrencies and I have a sordid history. It began with me comparing BitCoin to a pyramid scheme, pointing out the issues that were obvious to many casual observers and receiving some good feedback in the process. Over time I became more comfortable with the idea, although still lamenting the volatility and obvious market speculation, and would go as far to say I was an advocate for it, wanting it to succeed in its endeavours. Then I met the community, filled with outright hostile individuals who couldn’t tolerate any criticism and acted like they were the victim of the oppressive government regime. I decided then that I wouldn’t bother blogging about BitCoin as much as I had done previously as I was just sick of the community that had grown around it.

Then came Dogecoin.
Dogecoin Thanks BTC LTCDogecoin, for the uninitiated, is a scrypt based cryptocurrency (meaning that it’s a memory-hard based currency, so the ASICs and other mining hardware that BitCoiners have invested in is useless for mining it) which bears the mark of the Internet meme Doge. The community that sprung up around it is the antithesis of what the BitCoin community has become, with every toxic behaviour lampooned and everyone encouraged to have fun with the idea. Indeed getting into Dogecoin is incredibly simple with tons of guides and dozens of users ready and willing to help you out should you need it. Even if you don’t have the hardware to mine at a decent rate you can still find yourself in possession of hundreds, if not thousands, of Dogecoins in a matter of minutes from any number of the facet services. This has led to a community of people who aren’t the technically elite or those looking to profit, something which I believe led to the other cryptocurrency communities to become so toxic.

I myself hold about 20,000 Doge after spending about a week’s worth of nights mining on my now 3 year old system. Whilst I haven’t done much more than that it was far, far more than I had ever thought about doing with any other cryptocurrency. My friends are also much more willing to talk to me about Dogecoin than Bitcoin with a few even going as far to mine a few to fool around with on Reddit. Whether they will ever be worth anything doesn’t really factor into the equation but even with their fraction of a penny value at the moment there’s still been some incredible stories of people making things happen using them.

For most of its life though the structural issues that plagued BitCoin where also inherent in Dogecoin, albeit in a much less severe manner. The initial disparity between early adopters and the unwashed masses is quite a lot smaller due to Dogecoins initial virility but there was still a supposed limit of 100 billion coins which still made it deflationary. However the limit wasn’t actually enforced and thus, in its initial incarnation, Dogecoin was inflationary and a debate erupted as to what was going to be done. Today Dogecoin’s creator made a decision and he elected to keep it that way.

One of my biggest arguments against BitCoin was its deflationary nature, not because it’s not inflationary or whatever argument people think I have against it, more that the deflationary nature of BitCoin encouraged speculation and hoarding rather than spending. Whilst the inflation at this point is probably a little too high (I.E. the price instability is mostly due to new coin creation than much else) it does prevent people attempting to use Dogecoin as a speculative investment vehicle. Indeed the reaction from a lot of those who don’t “get” Dogecoin have been lamenting this change but in all honesty this is the best decision that could be made and shows the Dogecoin creators understand the larger (non-technical) issues that plague BitCoin.

Will this mean that Dogecoin will become the cryptocurrency of choice? Likely not as with most of these nascent technologies they’ll likely be superseded by something better that addresses all the issues whilst bringing new features that the old systems simply cannot support. Still the fact that there has been an explosion in altcoins shows that there’s a market out there for cryptocurrencies with feature sets outside of what BitCoin provides. Whether they win out all depends on where the market wants to head.

The Difference Between Real Growth and Speculation (or The BitCoin Circlejerk Problem).

I had given up on writing on BitCoin because of the rather toxic community of people that seemed to appear whenever I wrote about it. They never left comments here, no instead they’d cherry pick my articles and then never attempt to read any of my further writings on the subject and then labelling me as a BitCoin cynic. It had gotten to the point where I simply couldn’t stomach most BitCoin articles because of the ensuing circlejerks that would follow afterwards where any valid criticism would be met with derision usually only found in Call of Duty matches. But the last couple months of stratospheric growth and volatility have had me pulling at my self impost reigns, just wanting to put these zealots in their place.

Since I can’t find anything better to post about it seems that today will be that day.

BitCoin Price Chart Jan13 to Dec13The last time I posted about BitCoins they were hovering around $25 (this was at the start of the year, mind you), a price that was not seen for a long time previously. It began a somewhat steady tend upwards after that however it then had another great jump into the $100~$200 range something I long expected to be completely unsustainable. It managed to keep around that area for a long time however but the end of October saw it begin an upward trend that didn’t show many signs of stopping until recently and the past couple weeks have been an insane roller coaster ride of fluctuating prices that no currency should ever undergo.

Much of the initial growth was attributed to the fact that China was now becoming interested in BitCoins and thus there was a whole new market of capital being injected into the economy. Whilst this might have fuelled the initial bump we saw back in the end of October the resulting stratospheric rise, where the price doubled in under a month, could simply not be the result of new investors buying into the market. The reasoning behind this is the fact that the transaction volumes did not escalate at a similar pace meaning those ridiculously unsustainable growth rates were driven by speculative investors looking to increase the value of their BitCoin portfolios, not a growing investor base.

The anointed champions of BitCoin won’t have a bar of that however, even when the vast majority of forums were flooded with people who were crying when they cashed out at $400, lamenting the fact they could have had 3 times more if they’d only waited another week. As I’ve said dozens of times in the past the fact that the primary use of BitCoin right now is speculative investment is antithetical to its aspirations to become a true currency. Indeed the fact that it’s deflationary means that it inherently encourages this kind of action rather than being a medium for the transfer of wealth between parties. Indeed the inflationary aspect of fiat currencies, which BitCoiners seem to hate for some reason, encourages people to spend it rather than simply hanging on to it.

The flow on effect of this rampant speculation is the wild fluctuations in value which make using it incredibly difficult for businesses. Indeed any business that was selling goods for BitCoin prior to the current crash has lost money on any goods they sold simply because of the fluctuations in price. Others would argue that typically the retailers are better off because the price of BitCoin trends upwards but history has shown that you simply can’t rely on that and it’s guaranteed that unless you exchange your BitCoins for hard currency immediately after purchases you’re likely to hit a period of instability where you’ll end up on the losing end of the equation.

Whilst I’m sure I’ve lost all the True BitCoin Believers at this point I feel I have to make the point that I think the idea of cryptocurrencies are great as they’d be a great alternate method for transferring wealth across the world. BitCoin has some fundamental issues, many of which can’t be solved by a simple work around here or there, and as such whilst I won’t advocate its wholesale abandonment I would encourage the development of alternatives to address these issues. Unfortunately none have been particularly forthcoming but as BitCoin continues to draw more attention to itself I can’t imagine they’re too far off and then hopefully we can have the decentralized method of transferring wealth all BitCoiners like to talk about.

 

Why You Shouldn’t Invest In BitCoins.

Much like my stance on Instagram I’ve seemingly been at odds with the BitCoin community ever since I penned my first post on it almost 2 years ago. The angst seems to stem primarily from the fact that I lumped it in with Ponzi schemes thanks to its early adopter favouritism and reliance on outside wealth injection. After the first crash however BitCoins started to show some stability and their intended function started to be their primary use. Indeed the amount of investment in the BitCoin ecosystem has sky-rocketed in the past year or so and this had led to a period of much more mild growth that was far more sustainable than its previous spikes were.

It was for that reason that I held my tongue on the latest round of price volatility as I assumed it was just the market recovering from the shock of the Pirateat40 scheme unravelling. That particular incident had all the makings of another price crash but it was obvious that whilst there was a great deal of value lost it wasn’t enough to make a lasting impression on the economy and it soon recovered back to a healthy percentage of its previous value. The last month however has started to show some worrying trends that hark back to the speculative bubble.

BitCoin Price Chart

If you zoom in on either of those 2 ramps the gradients are frighteningly similar although the price jump is from $15 to $25 rather than $3 to $10. Whilst the value jump might not be as severe as it was before (~66% rather than 300%) it’s still cause for some concern due to the time frame that it has happened in. When the value jumps up this fast it encourages people to keep their BitCoins rather than using them and attracts those who are looking to make a return. This puts even more upward pressure on the price which eventually leads to the kind of value crash that happened back in 2011.

Others would disagree with me however, saying that its actually a great time to invest in BitCoins. The reasons Anzaldi gives for wanting you to invest in BitCoins however don’t make a whole lot of sense as he doesn’t believe this round of growth is unsustainable (and even admits that the only other thing that gives this kind of ROI are all scams) and that the reward halving coupled with the deployment of ASIC chips are what are behind this stratospheric, real growth. The fact of the matter is that neither of these really has any influence over the current market rate for BitCoins, it all comes down to what people are willing to pay for them.

Prior to the lead up of the previous crash BitCoins had already experienced some pretty crazy growth, going from prices measured in cents to dollars in the space of a couple months. This immediately led to a flood of people entering the market who were seeking fast returns and had no intention of using BitCoins for their intended purpose. This current round of growth feels eerily familiar to back then and with people seeing rapid growth its highly likely that those same speculators will come back. It’s those speculators that are driving the price of BitCoins up not the factors that Anzaldi claims. If they were the price would have begun this current upward trend back in November (it did go up, but not like this and stablized shortly after) and the introduction of ASICs is far more likely to flood the market with more coins as hardware investors look to recoup some of their investments, rather than holding onto them for the long haul.

This kind of wild volatility isn’t helping BitCoins intended use as an universal currency that was free of any central agency. If this growth spurt leads to a new stable equilibrium then no harm, no foul but it really does look like history repeating itself. I’m hopeful that the market is smart enough to realise this and not get caught up in a buy and hold spree however as they’ve managed to do that in the past. As long as we remember that it’s BitCoin’s worth is derived from its liquidity and not its  value then these kinds of knife edge situations can be avoided.

Finding The Ideal BitCoin Exchange Rate.

BitCoins are a hybrid of two currency models, namely the current world standard of fiat currency (I.E. BitCoins only have value because other people will accept them in exchange for goods and services) and the traditional gold standard due to the availability being limited. Combined with the other properties such as transaction anonymity (within reason), no central system regulating transactions and worldwide reach BitCoins have all the features it needs to be a great vehicle for the transfer of wealth. Long time readers will know that there are some issues that plague the BitCoin ecosystem, mostly due to its relatively low transaction volume and misclassification as an investment vehicle by some, but these are things that can be solved with time and more investments.

One thing that always gets to me though is any time that BitCoins start to trend upward nearly every news outlet looking for a story will herald it as a second coming of BitCoin after the devastation wrought by the speculative bubble last year. I’ve made the case several times over that an increase in price is no indication of health within the BitCoin economy and in fact any sharp uptick in price is actually quite hurtful as it signals that BitCoins are better left unspent as it makes no sense to spend them when simply waiting will give you a discount. This hoarding mentality is what led to the speculative bubble last year as supply dried up and prices went through the roof. It didn’t last long however and the price came crashing back down to reality (and then some).

 I don’t discount that all growth within the BitCoin economy is a bad thing however, just the volatility. Indeed there was a good period of 6 months this year when BitCoin’s price was relatively stable and that’s what it needs to be in order for commerce to take the currency seriously. Taking this idea further there has to be a price equilibrium where the exchange rate is truly representative of all the wealth contained with BitCoins and this is the point where the market should aim towards. Figuring out that particular price isn’t easy though and I can only really give a semi-education guess as an answer.

The longest time that BitCoin spent in relative stability was around the $5 mark from around May this year. Since then there have been another 1.2 million BitCoins added into circulation, an approximate 13% increase. In a completely stable exchange this would have put a downward pressure on the exchange rate which would have decreased the real value by a similar percentage. To keep the value “ideal” then, I.E. the real purchasing power the same, the exchange rate should go up by that rate instead giving us a new price of $5.65.

Of course this completely ignores the amount of potential wealth that could be contained within the BitCoin economy. A country’s currency is usually a reflection of the health of its underlying economy and BitCoin is no exception to this but we don’t have other metrics like GDP in which to get a good idea for how much wealth is backing it. Transactions volumes, exchange rates and total coins in circulation are only rough metrics and we’ve seen in the past how these things aren’t great indicators for the health of BitCoin.

Realistically the best exchange rate for BitCoins will be the one that it ultimately settles on once transaction volumes ramp up again and the investor market segment starts to become more and more irrelevant. Whether this is above or below the current rate is really anyone’s guess however we should still abstain from saying that the rising price of a BitCoin is a sign of market health as it’s simply not. Whilst the price rise is no where near as rapid as it was last year it’s still light years ahead of any other currency on the planet and as history has shown that kind of growth just isn’t sustainable. The next 6 months will be very telling for the BitCoin economy as we’ll see if this growth levels out into a new stable equilibrium or if it’s just the beginning of another speculative bubble.

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.

The Last Thing BitCoin Needs: Rising Exchange Rates.

In regular financial markets the value of a country’s currency is a great marker for how well it’s doing in economic terms. The surge in value of the Australian currency over the past 2 years demonstrates how strong our economy was in comparison to the rest of the world, mostly thanks to our strong capitalization of our banks couple with some pocket change from the mining and resources boom. However there’s one particular exchange rate where the value of the currency is actually irrelevant to the strength of the underlying economy and a high trading price actually signals that there’s something going horribly wrong. The economy I’m referring to is the one of the online cryptocurrency BitCoin.

Long time readers will know that I was very skeptical about the idea at first as it harked back to the days of other online currencies that were ripe for exploitation and all of which inevitably fell down, sometimes with catastrophic consequences. My concerns were mainly centred around the immense amount of wealth that that was concentrated in the hands of the early adopters but over time it shifted to the crazy exchange rates that BitCoins were attracting which inevitably lead to the price crash that happened in the middle of last year. Since then I’ve been more bullish on the idea of BitCoins because the price has remained steady whilst transaction volumes have started to rise, showing that BitCoins can actually function as a proper currency and not a speculative investment vehicle.

However over the last month or so BitCoin’s exchange rate has been creeping up steadily and the last week alone has seen massive gains in the current trading price:

As you can see for the past 6 months or so the price of BitCoins has been relatively steady, trading at around $5 for a good length of time. However just over a month ago the value started to slowly tick upwards and the last two weeks have seen that value explode in some rapid gains, culminating in a massive jump of almost 20% in under a week. Whilst it’s nothing like the speculative bubble of last year it does raise concerns that the stability of the BitCoin currency was short lived and the speculators have come back to the market looking to derive some more short term gains from the market they successfully pillaged last year.

Increases like this remind us of the unfortunate fact that at its current size the BitCoin market is still volatile as there are strong correlations between large transaction volumes and huge swings in the exchange rate. This is not a desirable attribute for a currency and is much more amenable to speculative trading, something which has burned BitCoin users in the past. Indeed a rising BitCoin value should cause a rational actor to hold off using is as a currency as they would instead want to hold onto them for as long as possible in order to extract the maximum amount of gain out of them. Such thinking is what lead to the BitCoin price to reach such dizzying heights last year and this last bump in the price has the potential to do it all over again.

For BitCoin’s sake I hope this isn’t the case as there are many innovative companies betting their core business on the BitCoin idea and a volatile market could easily spell the end for them. It’s quite possible that these latest bumps are just blips on the radar but the steady rise over the last month or so really has me worried about a repeat of the speculative bubble that happened last year. Can the BitCoin market correct for this kind of behaviour? Will passionate BitCoiners get roped back into the idea that their BitCoins are investment and not a wealth transfer vehicle? I don’t have straight answers to these questions but the next couple months will show if the BitCoin market can learn from the mistakes of its past and hopefully overcome them to become the real virtual currency it has always strived to be.

A $500,000 Bet on BitCoin.

It’s no secret that I’m somewhat bearish when it comes to BitCoins. Fundamentally I think the idea is sound as cryptocurrencies have the potential to revolutionize the currency and exchange industry in the same way the Internet did for the communications. The current implementation though is plagued with non-technical problems mostly due to how easy it is to influence the price with transaction volumes that aren’t particularly large. Transaction volume has been increasing however and when this is coupled with conversion stability we will have the potential for cryptocurrencies to move out of the tech niche they’re in and become a fully fledged means for transferring wealth around the world.

Getting BitCoin to work then relies on making it a desirable currency to use in place of more traditional means. For the most part people have focused on using it either as an add-on to their existing business (we now accept BitCoins!) or creating a new business from scratch based solely around the idea of using BitCoins. If I’m honest the latter feels like people seeing BitCoins as an opener to their 4 Hour Work Week style businesses which, especially if their only distinction from the competition is accepting BitCoins, don’t do too well in today’s aggressive market place.

Apart from these types of businesses and the ancillary ones that surround every currency (exchanges, banks, gambling sites, etc.) I hadn’t really seen much innovation in the BitCoin space right up until I read an article about CoinLab.

CoinLab is in essence a library for game developers that allows users to generate in game currency in exchange for using their idle compute power to mine BitCoins on the network. The idea is that oing this will net the companies much more dollars per user than advertising or micro-transaction due to the seamless nature of it and the tendency for people to do almost anything to get something for free. The idea isn’t particularly new, there have been many products that have paid users to use their extra computing power, but the integration with BitCoins certainly is. The question then becomes how sustainable such a business model is and going off the fact that CoinLab just netted $500,000 from investors to prove the idea would lead you believe that there’s some merit to this idea.

The last few months have been rather good for BitCoin with the price being stable at around $5. Additionally the transaction volume has remained relatively steady showing that there’s base level demand for the currency that can be depended on. This works in CoinLab’s favour as a business model that was viable during the speculative bubble last year would not be long for this work, but at a stable and predictable rate of conversion you’re far more likely to hit on a sustainable business rather than a flash in the pan. What’s working against them however is the increasing difficulty built into the system which will make generating new coins harder over time.

This is somewhat counteracted  by increasing user numbers which gives you more compute power and thus more chance at getting coins, but it’s the difference between the two that will be the deciding factor in how far the business can scale. The end game for such a company would eventually be a transaction processing house using their legions of computers as a big exchange network and taking transaction fees instead of mining but whether that’s sustainable or not is a question I don’t yet have the answer to. It will be very interesting to see where CoinLab goes with this and I hope they’re as open with their figures as the rest of the BitCoin industry has been thus far.

BitCoins are definitely a catalyst for new kinds of innovation in an industry that’s typically been glacially slow to integrate with new technologies. Startups like CoinLab are doing the hard yards to make cryptocurrencies viable for everyone else by increasing the base transaction volume so the price isn’t as susceptible to wild manipulation like it was in the past. I may still be bearish on the BitCoin idea but many of my initial complaints are starting to be overcome through innovative uses that I hadn’t once thought of. I’ll be watching developments in this area keenly and who knows, I might even dive into it myself.

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.

With the Bubble Burst Has BitCoin Become the Currency it Strived to be?

At the time that I wrote that the BitCoin bubble was bursting I wasn’t really sure just how far the digital currency’s value would decline. Well here we are 3 months on and the value of a BitCoin has slumped to approximately US$3, an order of magnitude less than the dizzying highs it was on all those months ago. I made the prediction back then that once everyone stopped treating BitCoins as an investment vehicle the nascent currency could actually become what it strived to be rather than a speculator’s wet dream. So since one half of my prediction came true (the arguably easy to predict part) one has to wonder, how is BitCoin doing as a currency now?

Image used under a Creative Commons license from BitCoinCharts

The chart above details the dramatic rise and fall of the BitCoin price over the past year. As you can see whilst the value (the line graph) of a BitCoin may have tanked significantly it is still higher than that of what it was a year ago, by a large factor. What’s interesting to note though is the trade volume (the bar graph) which you can see in the months preceding the speculative bubble was quite low, almost non-existent for some months. The trading volume after the peak however as been far more active than it has been previously from which we can draw some conclusions about the BitCoin market.

Now the first conclusion I drew from this graph was that the market is becoming far more liquid with more buyers and sellers entering the market. Of course this high level of market activity could also be people attempting to sell down their BitCoin holdings, but that just favours the buyer side of the equation which is what is driving the price down. The volatility in the price is still very much at odds with its aspirations to become a real currency however so until the price hits a floor and stays there for a couple months BitCoin will struggle to be more widely adopted as a transaction medium.

The biggest impact that the drop in price will have though is the drop in free infrastructure it was getting from people mining for BitCoins. Whilst GPU mining was very profitable in the $15+ range when you’re getting down around these price levels it’s really not economically viable to mine coins. Thus the only people who will still do it are the ones who believe in the idea and want to help out or those who are running BitCoin services like Mt.Gox. Whilst that’s far from the BitCoin infrastructure just up and disappearing it does mean that many people who flocked to the BitCoin idea because of the financial feasibility of it will drop it in favour of greener pastures, whatever they might be.

Thus the burst BitCoin bubble is something of a mixed bag. Whilst the increased liquidity and speculator free market is definitely a great help to BitCoin becoming a serious currency the continued price instability and loss of supporters negates those benefits completely. The price crash also hasn’t addressed the early adopter problem either, leaving swaths of easily had BitCoins in the hands of a small collective of users.

Summing these all up together it seems that, as a currency at least, BitCoin is still just another alternative currency that’s struggling to achieve the goals it set out to accomplish. Technically it’s a masterful system that’s remained resistant to nearly all attempts to break it with all the problems coming from external parties and not the BitCoin system itself. However the economics of BitCoin are the real issue here and those things can’t be overcome with technical genius alone. BitCoin still has a long, long way to go before anyone can seriously consider it as a currency and there’s no telling if it’ll last long enough for it’s teething problems to be overcome.