Here's my proposal: let's forget exchange rates. Let's not confuse them with inflation[0]. That's a red herring. Exchange rates are important for BTC's legal users now because there's not (yet) production in BitCoin's economy. Apart from drugs[1], BTC is pure store of value, and it should be analyzed as such.
This is important for this discussion, because exchange rates ultimately won't matter that much. By "ultimately", I mean that phase of development when (if) BitCoin becomes a full currency, that is, when there's somebody, some corporation, operating and trading significantly in the currency. I won't lend the status of currency to any commodity which is not used this way.
And what's clear is that both BitCoin and gold are shit currencies. Even conceding the exchange rate could stabilize enough for a modern day Rockefeller[2] to pull it to a success, you still would have to contend with the deflation inherent in this "currency".
There's a reason why gold is traded in commodities markets -- and not as a currency. There's a reason why banks and states trade and store USD, instead of gold. You simply can't grow an economy like it's the 20th century with gold, or BitCoin. In fact, BitCoin is even more ruthless than gold. 19th century economies could at least pray for the discovery of a gold vein, to alleviate their deflationary comedowns. BitCoin denies even this possibility with the cold, germanic efficiency of a mathematical proof.
[0] The exchange rate we run against our future selves, if you will.
[1] Which doesn't count anyhow, since you would agree there's a risk markup on them for their illegal status, which makes dubious extrapolating any analysis from them.
[2] An improbably apt group of entrepreneurs, who even more improbably would decide to bet their future fortunes on a currency designed by computer geeks with a penchant for goldbuggering.
"You simply can't grow an economy like it's the 20th century with gold, or BitCoin"
Well, the past 4 years have proven you wrong.
Explain how the Bitcoin economy has been able to grow so much since 2009? Why is it that 10,000+ merchants decided to use Bitcoin through Bitpay alone? Why is it that Bitcoin gains more and more users every day?
The answer is that, even if deflation was a problem, which is itself debated [1], Bitcoin's advantages such as being censorship-resistant are unparalleled by any other currency, and that alone gives Bitcoin the ability to succeed where no other currency could.
The fact that Bitcoin is deflationary is purely a product of the software/protocol. Given consensus to change it, one could make it inflationary easily. E.g. by having blocks always pay out 25 btc as a reward or even have successive blocks pay out increasing rewards.
I agree that the critical problem with Bitcoin is the inability to inflate at a controlled rate. It inevitably follows from the idea of having a decentralized currency - something has to control currency creation rates, and if you aren't going to trust an organization of people, then math is the only alternative, which is kinda both empowering and limiting. Because of that alone, if nothing else, I don't think we'll ever have a major economy in Bitcoin only.
That doesn't mean there's no use for it though. There may well be purposes and segments of the economy that find it very useful, and it may even be possible at some point for people in some niche markets/occupations to exist entirely in a Bitcoin economy. It'll just never be very big compared to any first-world national currency.
I have yet to see a scholarly article showing that productivity caused deflation (currency held constant while increases in population or productivity cause prices to drop) has caused economic problems. There is much evidence of currency removal caused deflation (when a large amount of currency or credit is quickly removed from the system causing prices to drop) wreaking havoc on the economy.
I am interested if you have seen any documented evidence of the former?
Also, in the US under the gold standard (1776-1910), we saw history's greatest increase in individual wealth ever recorded (measured by per capita GDP). Yes it was more volatile than under a fiat currency, but it's hard to argue that a constant or slow growing currency dampens economic growth with that data point.
Exchange rates are important because they indicate a bigger design flaw than the fixed supply: there's no entity with the ability to prop up demand. By contrast, responsible governments with effective tax collecting powers can generally exert a large degree of control over the purchasing power of their currency. The dollar is backed by all taxable economic activity in the United States. Stocks, which often end up worthless after promising starts, are at least backed by assets that can generate future cashflows. Bitcoin is backed by faith.
Even if BTC is better to transact with in every conceivable way, businesses will still need hard currency to pay their taxes, which makes exchange rate and liquidity risk a very real concern if you're trading real assets for BTC.
> There's a reason why banks and states trade and store USD, instead of gold.
Suppose you accumulate a lot of debt in a currency backed by gold. Further suppose that you control that currency, and have the power to change or remove the gold backing. It becomes very tempting to, say, issue some new currency with lower or zero gold backing to wipe out your debt.
> Let's say, for example, a vendor is considering whether to begin accepting bitcoin. She will need to be able feel relatively certain that, when she leaves the storefront in the evening, she will have nearly the same amount of value on balance when she returns the next morning.
Fortunately, vendors don't have to take on any such risk. There are services (e.g. CoinBase, BitPay) that let sellers accept bitcoin without ever holding a bitcoin balance. These services effectively instantly convert bitcoin revenue into something less volatile (e.g. USD).
that does not address the volatility issue at all - even if bitcoin are converted immediately to dollars or euros, because they fluctuate so wildly, no business would be able to know if the amount they receive will even cover their cost or if suddenly they are charging way way 'too much'.
I think BitCoin could be a great answer to the global dissatisfaction with the dollar as the world reserve currency. Why not use bitcoin as a non-political global reserve currency, and as an intermediary between national currencies, rather than as an everyday currency that intends to replace anything.
Transaction to Trade ratio is going up. For whatever reason, a significant portion of BTCs (in some data-points... as much as 60% of BTC transactions) have been in exchanges.
IE: BTC is probably going through a bubble right now, as any commodity. In the first few weeks of October, there were periods where MOST transactions were purely for speculation / trading.
Trade volume is on the rise. I don't know why or how, but a group of investors has decided to start speculating on BTCs.
------------------
Instead, for BTC to be a "useful currency", people need to transfer BTCs between each other and stop speculating on BTC / USD exchanges. Whenever there is a rise of speculators, I'm going to bet on a bubble.
One tidbit that continues to bother me regarding the long-term viability of bitcoin is how long the encryption processes it relies on will stay secure. IIRC bitcoin relies on ECDSA for signing and SHA-256 for hashing.
Pretty much all forms of encryption have a shelf-life until they are broken, especially when you consider quantum computing on the horizon. What happens when ECDSA becomes viable to break, or when they start finding SHA-256 collisions? Would the currency just collapse, or is there some way provided to change the system's cryptography methods?
Is the volatility graph of Bitcoin in this article really representative?
Some people have mentioned that in the huge price spike in April, there were not actually that many people buying, and then there is this article on Bitcoin spreads that calls into question whether Mt. Gox is the best measure:
http://www.forbes.com/sites/beltway/2013/09/03/how-bitcoin-s...
The spreads are so weird because of the difficulties with fiat currencies. Mt. Gox allows you to deposit/withdraw BTC no problem, but it charges a notorious premium if you want to withdraw USD. As a result, the BTC-USD prices are elevated by the premium.
Sites like Coinbase or Bitstamp that don't charge as much to deposit or withdraw will probably be a more accurate way to judge BTC-USD.
The article is right on one point: Bitcoin is volatile. No one denies that.
However the article is wrong that "volatility must decrease for it to survive". If anything, the fact it has not only survived for 4 years, but succeeded by gaining market share and gaining value (1000x since 2010!) despite its volatility shows that the market does not care that much about volatility.
When the article talks about Bitcon's need to "survive," I interpreted it to mean "survive [as a currency]." Bitcoin makes a fine speculative trading vehicle for those with the cojones to expose themselves to big positions. But as a currency, it does need to "settle down." Think about it from the perspective of a business intending to transact in Bitcoin and prepare for the years ahead. Inventory management, logistics, financial planning, and all the other necessities of running a business as a going concern are extraordinarily difficult when the currency one accepts is fluctuating this wildly.
Exchanges, such as the late Silk Road, do not hold their own inventory, and so those types of businesses make some degree of sense. (Even still, they'd have a very hard time attracting investment, if they ever sought it, because the company's fundamental financial position would change on a daily basis.)
But businesses other than open exchanges face some very serious difficulties when conducting business in BTC. This is one major source of the liquidity issue. The other is that speculative holders and traders far outweigh transactors in terms of the currency's total trading volume. BTC changes hands quite often, but not typically in the form of business transactions, which one would expect of a currency. Far more often it's in the form of buy and sell orders, like a commodity.
Bitcoin has a market cap around $2 billion. To be a major currency, it needs a much larger cap, maybe a hundred billion. A major price increase would count as volatility but it's the only path from here to there.
It doesn't have to be a major currency. No one (I think) is suggesting it replace the dollar. Maybe it can be a minor currency that works along with the dollar. There are certain things you can do with bitcoins that you can't with fiat.
Bitcoin volatility won't decrease for a long time. Right now we're in the first major phase of Bitcoin's evolution, wherein the global financial system slowly wraps it's collective brain around what Bitcoin is, how it behaves, and what it's good for.
Even experts in cryptocurrency don't agree about any of those things, so global consensus about those three things is a long way off.
A few basics are starting to emerge:
* Bitcoin is good for transactions that governments don't want you to make.
* Bitcoin is good for transactions between vastly different financial and legal systems.
* Bitcoin is good for storing money in your brain.
* Some subset of people feel Bitcoin is a good investment.
But even now, there are many people with money, not to mention many financial experts, who are not so sure about these things. With every WSJ article we creep closer and closer to consensus, but it is still quite far off.
That said, eventually the global financial markets will start to agree about these uses, and a generally accepted model will emerge. I suspect this will take at least 20 years, which is the length of time it will take for us to start having University Faculty who went through their entire undergraduate education with Bitcoin existing and at least partially understood by their professors.
That model will be something like:
Bitcoin market cap = I + f(V)
where V = volume of global transactions for which Bitcoin is the best choice
f(V) = the float required to make those transactions
I = the amount of capital for which Bitcoin is the best investment vehicle
And of course we need models for each of these... V is going to be some portion of illegal transactions, some portion of inter-border transactions, etc. We really have no idea what this is right now.
Until then the price of Bitcoin will be very chaotic, which will influence the I term, but not the V term. The V term is just a pure result of how many people have need for a Bitcoin-like currency, and what percentage of those people are aware of Bitcoin and have the technical means to use it.
BUT, when the global financial markets do start to reach consensus on the model, then Bitcoin will stabilize. And I don't mean it will stabilize as a deflationary currency, I mean it will literally be flat. Because the financial markets have NO problem pricing deflation into their models and they absolutely will. The price will go up to where you can't make money investing in Bitcoin during a reasonable slice of a human lifetime, and then level off.
And I suspect Bitcoin will stabilize MUCH more than traditional currencies. Because there will be no capriciousness of international politics or policy, the Bitcoin price model will be based on much more stable factors: global crime, global population, etc. And those things are much easier to model than things like U.S. foreign policy.
So anyone who is thinking either A) Bitcoin has a chance at stabilizing in the next 10 years, B) Bitcoin will deflate forever, or C) Bitcoin will never stabilize, I just don't agree. It's just going to take a while.
with V ≈ 0, since gold isn't used for many transactions? (AFAIK)
Why hasn't gold stabilized entirely? Are there reasons why it's affected by capricious international politics or policy, but Bitcoin won't be?
If I had to guess, I'd say that Bitcoin, like gold, will be affected by e.g. future economic delveragings that cause people to expect that the government might print money.
[+] [-] lolcraft|12 years ago|reply
This is important for this discussion, because exchange rates ultimately won't matter that much. By "ultimately", I mean that phase of development when (if) BitCoin becomes a full currency, that is, when there's somebody, some corporation, operating and trading significantly in the currency. I won't lend the status of currency to any commodity which is not used this way.
And what's clear is that both BitCoin and gold are shit currencies. Even conceding the exchange rate could stabilize enough for a modern day Rockefeller[2] to pull it to a success, you still would have to contend with the deflation inherent in this "currency".
There's a reason why gold is traded in commodities markets -- and not as a currency. There's a reason why banks and states trade and store USD, instead of gold. You simply can't grow an economy like it's the 20th century with gold, or BitCoin. In fact, BitCoin is even more ruthless than gold. 19th century economies could at least pray for the discovery of a gold vein, to alleviate their deflationary comedowns. BitCoin denies even this possibility with the cold, germanic efficiency of a mathematical proof.
[0] The exchange rate we run against our future selves, if you will.
[1] Which doesn't count anyhow, since you would agree there's a risk markup on them for their illegal status, which makes dubious extrapolating any analysis from them.
[2] An improbably apt group of entrepreneurs, who even more improbably would decide to bet their future fortunes on a currency designed by computer geeks with a penchant for goldbuggering.
[+] [-] mrb|12 years ago|reply
Well, the past 4 years have proven you wrong.
Explain how the Bitcoin economy has been able to grow so much since 2009? Why is it that 10,000+ merchants decided to use Bitcoin through Bitpay alone? Why is it that Bitcoin gains more and more users every day?
The answer is that, even if deflation was a problem, which is itself debated [1], Bitcoin's advantages such as being censorship-resistant are unparalleled by any other currency, and that alone gives Bitcoin the ability to succeed where no other currency could.
[1] http://www.forbes.com/sites/jonmatonis/2012/12/23/fear-not-d...
[+] [-] anologwintermut|12 years ago|reply
[+] [-] ufmace|12 years ago|reply
That doesn't mean there's no use for it though. There may well be purposes and segments of the economy that find it very useful, and it may even be possible at some point for people in some niche markets/occupations to exist entirely in a Bitcoin economy. It'll just never be very big compared to any first-world national currency.
[+] [-] jpadkins|12 years ago|reply
I am interested if you have seen any documented evidence of the former?
Also, in the US under the gold standard (1776-1910), we saw history's greatest increase in individual wealth ever recorded (measured by per capita GDP). Yes it was more volatile than under a fiat currency, but it's hard to argue that a constant or slow growing currency dampens economic growth with that data point.
[+] [-] notahacker|12 years ago|reply
Even if BTC is better to transact with in every conceivable way, businesses will still need hard currency to pay their taxes, which makes exchange rate and liquidity risk a very real concern if you're trading real assets for BTC.
[+] [-] marcell|12 years ago|reply
Suppose you accumulate a lot of debt in a currency backed by gold. Further suppose that you control that currency, and have the power to change or remove the gold backing. It becomes very tempting to, say, issue some new currency with lower or zero gold backing to wipe out your debt.
[+] [-] RoboTeddy|12 years ago|reply
Fortunately, vendors don't have to take on any such risk. There are services (e.g. CoinBase, BitPay) that let sellers accept bitcoin without ever holding a bitcoin balance. These services effectively instantly convert bitcoin revenue into something less volatile (e.g. USD).
[+] [-] lingben|12 years ago|reply
[+] [-] j2d3|12 years ago|reply
[+] [-] dragontamer|12 years ago|reply
Transaction to Trade ratio is going up. For whatever reason, a significant portion of BTCs (in some data-points... as much as 60% of BTC transactions) have been in exchanges.
IE: BTC is probably going through a bubble right now, as any commodity. In the first few weeks of October, there were periods where MOST transactions were purely for speculation / trading.
http://blockchain.info/charts/trade-volume
Trade volume is on the rise. I don't know why or how, but a group of investors has decided to start speculating on BTCs.
------------------
Instead, for BTC to be a "useful currency", people need to transfer BTCs between each other and stop speculating on BTC / USD exchanges. Whenever there is a rise of speculators, I'm going to bet on a bubble.
[+] [-] zalzane|12 years ago|reply
Pretty much all forms of encryption have a shelf-life until they are broken, especially when you consider quantum computing on the horizon. What happens when ECDSA becomes viable to break, or when they start finding SHA-256 collisions? Would the currency just collapse, or is there some way provided to change the system's cryptography methods?
[+] [-] gwern|12 years ago|reply
[+] [-] jdmitch|12 years ago|reply
Some people have mentioned that in the huge price spike in April, there were not actually that many people buying, and then there is this article on Bitcoin spreads that calls into question whether Mt. Gox is the best measure: http://www.forbes.com/sites/beltway/2013/09/03/how-bitcoin-s...
[+] [-] aqme28|12 years ago|reply
Sites like Coinbase or Bitstamp that don't charge as much to deposit or withdraw will probably be a more accurate way to judge BTC-USD.
[+] [-] mrb|12 years ago|reply
However the article is wrong that "volatility must decrease for it to survive". If anything, the fact it has not only survived for 4 years, but succeeded by gaining market share and gaining value (1000x since 2010!) despite its volatility shows that the market does not care that much about volatility.
[+] [-] jonnathanson|12 years ago|reply
Exchanges, such as the late Silk Road, do not hold their own inventory, and so those types of businesses make some degree of sense. (Even still, they'd have a very hard time attracting investment, if they ever sought it, because the company's fundamental financial position would change on a daily basis.)
But businesses other than open exchanges face some very serious difficulties when conducting business in BTC. This is one major source of the liquidity issue. The other is that speculative holders and traders far outweigh transactors in terms of the currency's total trading volume. BTC changes hands quite often, but not typically in the form of business transactions, which one would expect of a currency. Far more often it's in the form of buy and sell orders, like a commodity.
[+] [-] agorinto|12 years ago|reply
[+] [-] DennisP|12 years ago|reply
[+] [-] robotcookies|12 years ago|reply
[+] [-] saejox|12 years ago|reply
But, i can't. So it's kinda worthless.
[+] [-] letney|12 years ago|reply
[+] [-] chris_mahan|12 years ago|reply
[+] [-] dublinben|12 years ago|reply
The transaction speed is an issue for physical purchases too. Only checks take longer to clear, and they're pretty marginal.
[+] [-] erikpukinskis|12 years ago|reply
Even experts in cryptocurrency don't agree about any of those things, so global consensus about those three things is a long way off.
A few basics are starting to emerge:
* Bitcoin is good for transactions that governments don't want you to make.
* Bitcoin is good for transactions between vastly different financial and legal systems.
* Bitcoin is good for storing money in your brain.
* Some subset of people feel Bitcoin is a good investment.
But even now, there are many people with money, not to mention many financial experts, who are not so sure about these things. With every WSJ article we creep closer and closer to consensus, but it is still quite far off.
That said, eventually the global financial markets will start to agree about these uses, and a generally accepted model will emerge. I suspect this will take at least 20 years, which is the length of time it will take for us to start having University Faculty who went through their entire undergraduate education with Bitcoin existing and at least partially understood by their professors.
That model will be something like:
where V = volume of global transactions for which Bitcoin is the best choicef(V) = the float required to make those transactions
I = the amount of capital for which Bitcoin is the best investment vehicle
And of course we need models for each of these... V is going to be some portion of illegal transactions, some portion of inter-border transactions, etc. We really have no idea what this is right now.
Until then the price of Bitcoin will be very chaotic, which will influence the I term, but not the V term. The V term is just a pure result of how many people have need for a Bitcoin-like currency, and what percentage of those people are aware of Bitcoin and have the technical means to use it.
BUT, when the global financial markets do start to reach consensus on the model, then Bitcoin will stabilize. And I don't mean it will stabilize as a deflationary currency, I mean it will literally be flat. Because the financial markets have NO problem pricing deflation into their models and they absolutely will. The price will go up to where you can't make money investing in Bitcoin during a reasonable slice of a human lifetime, and then level off.
And I suspect Bitcoin will stabilize MUCH more than traditional currencies. Because there will be no capriciousness of international politics or policy, the Bitcoin price model will be based on much more stable factors: global crime, global population, etc. And those things are much easier to model than things like U.S. foreign policy.
So anyone who is thinking either A) Bitcoin has a chance at stabilizing in the next 10 years, B) Bitcoin will deflate forever, or C) Bitcoin will never stabilize, I just don't agree. It's just going to take a while.
[+] [-] RoboTeddy|12 years ago|reply
Why hasn't gold stabilized entirely? Are there reasons why it's affected by capricious international politics or policy, but Bitcoin won't be?
If I had to guess, I'd say that Bitcoin, like gold, will be affected by e.g. future economic delveragings that cause people to expect that the government might print money.