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.
My opinion hasn’t changed much in the month since I wrote my first post on how I think BitCoin is a pyramid scheme, ultimately destined to unravel unceremoniously when all the speculative investors decide to pull the plug and cash out of the BitCoin market. Still the discussion that that post spawned was quite enlightening, forcing me to clarify many points both in my own head and here on my blog. Since then there’s been a deluge of other blogs and press chiming in with similar opinions about BitCoin and how its intended purpose is far from its reality. There’s been enough noise about BitCoin’s issues that last week saw the first major dip in the exchange rate, and it hasn’t been smooth sailing since.
The image above is the historic trading price for BitCoins to USD on the biggest BitCoin exchange Mt.Gox. The BitCoin “Black Friday” can be seen as the first dip following the massive peak at around $30. Since that day BitCoin has been shedding value constantly with the latest bid offers hovering around the $18 mark. This is not the kind of volatility you see in something you’d class as a currency where single percentage changes are cause for concern and usually government intervention. In the space of a week BitCoin has shed almost half of its peak value which in any sane market would have seen suspension of trade to prevent a fire sale of the asset. The market isn’t showing any signs of recovering either as the market depth report from Mt.Gox shows:
There’s a very large discrepancy between the majority of seller’s idea of how much BitCoin is worth and what the market is willing to pay for it. The vast majority of sellers are looking to cash out at the mid-twenties range when the highest buy offer doesn’t even break the $20 mark. Any rational actor in this sort of market would be looking to get out before the market wipes out all of their value completely and for what its worth I believe the main speculators have probably already withdrawn from the market which is what triggered the initial dip in price. Liquidity in the BitCoin market is fast drying up and that will only serve to drive the price back to (or even below) its initial stable equilibrium.
On the surface this would appear to be the beginning of the end for BitCoin since confidence in the currency is rapidly disappearing with all the accumulated wealth that’s being lost to the diving market. However whilst many who were hoping to make their riches with a nascent currency might be finding themselves short changed the diving price of BitCoins means that those who were working against the currencies intentions, I.E. those who were using it as a speculative investment vehicle, are more likely to leave the market alone now that it’s been pumped and dumped. Once the price retreats back to more stable levels BitCoin could then start functioning as it is supposed to, as a vehicle for wealth that has no central authority regulating it.
It’s not going to be an easy road for BitCoin and its adopters though as confidence in the currency has been dashed with even some of its earliest supporters withdrawing from it. Mining will then no longer be a profit driven enterprise, instead run by those who support the idea and large companies like Mt.Gox who run exchanges. Once the idea that BitCoin’s value would ever be increasing has dissipated we may finally see a point where BitCoins are primarily used as a vehicle for value transfer and not speculative investment. It will probably be another month or two before we reach a new stable equilibrium in the BitCoin market but after that I might finally stop harping on about it being an elaborate (though probably unintentional) scheme.
This still doesn’t detract from the concentration of wealth for early adopters in the BitCoin ecosystem but once their incentive to hoard currency has vanished then the impact of their vast BitCoin stashes means a whole lot less than it did during the speculative price explosion. This will encourage them to put those BitCoins into circulation adding much needed liquidity to the market and hopefully restoring some more faith in the system. Time will tell if this works out however as with market volumes so low on the BitCoin exchanges price manipulation is bound to happen from time to time and realistically can only be solved by having wider adoption. I’m still not convinced that BitCoin is a safe place for any of my wealth currently but once its recovered from this rapidly bursting bubble I may revisit it, should the want arise.