Misunderstandings Leading to Increased Bitcoin Volatilty

hile there are many contributing factors to Bitcoin’s price volatility in relation to established government currencies one contributing factor is a misunderstanding of Bitcoin.

Bitcoin is a currency, a “commodity,” and payment system.  Many investors only see the commodity aspect and often point to “no intrinsic value.”  To an investor there is no “intrinsic value” because you cannot hold it or sell it if the value plummets.  For instance, even if the gold market crashes it still has value to make electronics and jewelry.  “Commodity” is in quotes because Bitcoin does fit the exact definition of a commodity but it is being discussed by regulators during recent US Senate hearings.

Non-investors often say Bitcoin does have intrinsic value as a payment system and a protocol.  For instance, the TCP/IP protocol has an “intrinsic value” in that it is used to operate the Internet.  The value of Bitcoin is in its use as a disruptive technology to displace outdated legacy services.  This disconnect is the result of different perspectives of the definition of “intrinsic value.”

Bitcoin is an experimental protocol.  Many discussions of Bitcoin compare it to established payment systems and conclude Bitcoin will be a failure.  While there are many issues with Bitcoin it is too early to make final conclusions about how it will pan out.  Someone looking at the Internet in the early 90’s would see rudimentary browsers that crash all the time and no search engines, no flash, no streaming video, no database-driven sites, etc.  If you ever sent your credit card info to a web site your funds would likely be stolen, and many businesses refused to have web sites because they were concerned about being associated with porn.  Some groups would claim that no advertising would be permitted on the Internet because it was designed for research collaboration.  Others claimed the Internet was for circumventing “real world” laws and used the Internet for all sorts of illegal things.  None of these issues, many of which still exist today, resulted in a “failure” of the Internet.

Exaggerations create false expectations.  Many people exaggerate the Bitcoin economy.  For instance, it is often stated that there are many thousands of merchants accepting Bitcoin.  While it may be technically true that thousands have signed up to accept Bitcoin the actual number of businesses selling things is substantially less.  For instance, BitcoinFood.com is a site maintained by Atlantic City Bitcoin.  It you exclude local places that accept Bitcoin the number of places accepting Bitcoin for mail order food is less than 50 for the entire world.  Of course this was probably less than 5 a year ago.  When you strip away all the hype over the exchange rate volatility Bitcoin is actually experiencing essentially a linear and steady growth.  Some misinterpret the overheated price and hype bubbles as a sign that Bitcoin has no underlying value at all and compare it to things like Beanie Babies.

Other exaggerations and misinterpretations include claims that Bitcoin will replace all currencies, that Bitcoin will cause the failure of central banks/the federal reserve/governments and so on, or that Bitcoin is solely as a tool to create “anarchy.”  Of course there is no way to predict how these things will pan out but those that focus on these hyperbolic issues rather than the how the technology can be used to disrupt current services often leads to misinterpretations and misunderstandings.

The Bitcoin price is a bubble, on top of volatility, on top of  a steady increase.  Bubbles are being caused by hype and misunderstandings, volatility is cause by lack of liquidation among exchanges, and the steady increase is due to the usefulness of the technology.  The volatility is often cites as a problem with merchants accepting the currency without considering that the problem may go away when liquidity is available.

Successful decentralized coin systems are not easy to launch.  Anyone can launch a new coin system since the software is based on open source and is freely available to anyone.  Hundreds of such systems have been launched (see CoinChoose.com).  However, a new systems takes a critical mass of users, miners willing to process the transactions, and merchants willing to accept the coin.  It is possible one of these systems will overtake Bitcoin in popularity but the chances of this are limited since Bitcoin users could decide to adopt some feature of these alternate coins if advantageous.  If Bitcoin does get replaced in popularity by some other system it would most likely be a system that is substantially different rather than one of these knock-offs.

Also see

Common Bitcoin Misconceptions – Great for new users and press reporters.



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