BT vs USD over 1 month via bitcoincharts

Over the last few months, the price of a bitcoin in USD blew up 6400% from $.50 to $32 before dropping as low as $15 over the last 2 days. This extreme market activity (along with the sensationalization of Silk Road) has caused a rapid increase in bitcoin investment and commentary. As a bitcoin enthusiast, I’ve decided to join the ranks of pro-bitcoin bloggers. This is at least partially a response to the lamestream meadia’s misunderstanding of and perhaps even hostility towards bitcoin. Keep reading for some analysis…

The following article presents a few nice examples of the misunderstanding and bad economics surrounding bitcoin:

First of all, as kleinma comments, Black Friday is an annual shopping day and Black Tuesday was when the stock market crashed in 1929.

Secondly, is this really a depression? I think commentator docbill makes some good points:

I agree [that marking the high and lows in less than a day isn't a good indicator of anything]. Even if you look at the week as a whole, there is no down trend. In fact if you look at the volume that traded at the higher value it was extremely small. The average sale price of bitcoins remained fairly stable. If you look since the start of the month, there is still a dramatic increase. If you look at it since the start of the year the increase is unheard of.

So, no. This is not a bitcoin depression. However, Mick continues with this false premise in order to promote market regulation:

Market volatility poses a very serious risk to BTC users — be they miners, traders, or merchants who accept BTC as payment for goods or services.  To that end, a major improvement would be for Bitcoin exchanges to implement mandatory market closures if the currency value dropped below a threshold.  In theory this would be relatively easy to implement, and we expect that it will be done at some point to prevent one-day flash inflation/deflation.

I agree that the bitcoin market is currently unstable. Docbill explains situation pretty well:

The real story [is] that the increase in the value of bitcoins has been much faster than the models predict. The reason is unjustified economic speculation. Less than 2% of bitcoins are being publicly traded. So huge changes in trade volumes are possible any given day. Hence, huge changes in price. The fact is a “currency” that increases in value over time, encourages saving, not investment. There will always be a low percentage of bitcoins on the market, so the market will always be very volatile.

But volatility is not inherently bad. One investor’s volatility is another’s opportunity. Mick’s suggestion of market closure as a means to prevent flash inflation/deflation is a terrible idea. I reject the valuation of de juro regulative “security” over the de facto loss of investor freedom. Bitcoin volatility represents the real risk involved in trading bitcoins. This risk is valuable information for investors and should not be obscured by the corrupting power of regulation. I would recommend that Mick study basic Austrian economics for more arguments against regulation.

But even if regulation were somehow a good idea, Mick’s regulatory proposal is effectively impossible. Since bitcoin markets are currently being developed as open source software, the barrier to creating a bitcoin market is very low. So, if any particular bitcoin market were to close during flash inflation/deflation, other markets would simply open or expand to accomodate the demand for transactions.

Finally, if stabilization is Mick’s goal, I believe that the market will naturally stabilize over the long term, as both the BT economy and international markets expand. It’s very possible that the market could collapse and stabilize at $0. But this is the nature of risk in a truly free market.

Despite Mick’s mischaracterization of bitcoin’s recent devaluation as a “depression” and his absurd regulatory proposal, his article does have some bright spots. Mick does an ok job describing bitcoin itself and addressing questions about anonymity. Mick also points out the real difficulty of bitcoin liquidity. Paypal has prohibited trading in bitcoins. Alternately, investors can transfer USD from their bank to dwolla to mtgox, but this process usually takes a few days. Bitcoin Money explains how this lag creates downward pressure on prices:

Bitcoin’s transaction volume is very active — over 10,000 transactions per day most recently.  Those numbers show Bitcoin’s progress much more than what is said by the results of a price move when heavy selling is occurring.  Those desiring to buy bitcoins at these selloff levels weren’t (and still aren’t) able to do so due to the delay in moving funds into the exchanges.

I agree with Mick that it would be great to debit BT. But credit purchases of BT are a terrible idea considering the ubiquity of credit card fraud. From this perspective the illiquidity of bitcoins is partially beneficial as an insulation from fraud.

Ultimately, I think lordylordy sums it up best:

“Black Friday of Bitcoins – The Depression Begins” is oh so much more exciting that “Bitcoin Prices Fall Back To Where They Were Three Days Ago.”

Related: What is Bitcoin?

Update: Yep… Price is bouncing back up around $20. 100% increase! White Sunday!

Update: Apparently Jason Mick did some research because his follow up article is pretty solid. Sorry for hatin… - Cracking the Bitcoin: Digging Into a $131M USD Virtual Currency by Jason Mick

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