Below are two separate charts that illustrate the same phenomenon: the relative volatility of a cryptocurrency called Bitcoin.
Over the past two years, the price of bitcoin – as measured in USD – has more than sextupled, rising from $234 per bitcoin in early May 2015 to just over $1,400 at the time of this writing.
Many vocal bitcoiners believe this is great for Bitcoin. But this is well-worn turf and a replay of what happened in 2014 and other boom and bust periods.
If you had bought bitcoins at nearly any time before today — and had not day traded them or lost them in any hundreds of ways — relative to most fiat currencies you have likely seen some large paper gains, at least until you sell them on a poorly run exchange. 1 But ignoring the counterparty risks of trading cryptocurrencies on unaccountable and unregulated exchanges there is a real problem for non-day traders and hoarders.
Chiefly, if you borrowed funds in bitcoin-denominated loans, you likely owe significantly more money than you did when the loan was originated. For instance, if you were using BTCJam and took out a long-term Bitcoin-denominated loan two years ago, as measured in USD, you would likely owe six times as much as you originally would… plus interest.
This is why, during bouts of prolonged deflation in the real-world, borrowers may walk away from large debts: they cannot pay back the principle let alone the interest. As a result, deflation-based economies can spiral into depression much as the Bitcoin economy experienced through much of 2014 and 2015 as it was propped up solely through venture capital funding and charity, most of which disappeared into companies like ChangeTip and CoinTerra.
What other areas of the Bitcoin economy are at-risk due to price appreciation?
- Payment processors who are solely dependent on Bitcoin transaction volumes. If consumers have a “high” time preference – and believe that price appreciation will continue – they will hoard and not spend as much as they otherwise would have due to opportunity costs. Why spend today when your bitcoins may go up in value 5% tomorrow? This deferred consumption is possible in Bitcoinland because most hoarders – as measured in multiple surveys – are typically “overbanked” and have access to other payment and credit mechanisms and facilities. Thus, if you run a payment processor, your aggregate volumes may decline during particularly high levels of volatility.
- Note: startups like Hedgy.co are no longer around to help provide FX hedging.
- Remittance companies – and their users – that need a stable price often require all parties to agree to a locked-in prices for at least 30-60 minutes before they can liquidate the coins on the receiving exchange. Bitcoin prices increased 5% alone today relative to USD. Even with hedging mechanisms, someone has to eat that volatility. It is ultimately a tax on at least one participant as there is no free lunch.
- Anyone using a wallet that sets a fixed, non-dynamic, fee to miners can be impacted. If the fee does not regularly adjust based on the external fiat value, a user could end up sending relatively high fees to miners in order to move any bitcoins.
There is a reoccurring theme here: the users with needs of “Bitcoin as a payment system” are diametrically opposite to users with the needs of “Bitcoin as a hoarding system.”
And it’s not really accurate to compare Bitcoin to gold either:
(1) As shown above in Figure 2, empirically, gold is measurably less volatile than Bitcoin over the past 8 years
(2) Gold does not have a perfectly inelastic supply: as price go up and down, gold miners will open and shutter ore mining operations. In contrast, Bitcoin has a perfectly inelastic supply and it doesn’t care if there are 1,000 “miners” or just 1 miner: the network generates the same amount of bitcoins roughly every 10 minutes on four year intervals because the marginal product of labor is zero.
A common retort is typically along the lines of: wallets using fixed-fee schedules are not likely to survive relative to those that offer price-contingent fee.
The problem is that as of right now — despite the theory and enthusiasm of “Oracles” — there is no native mechanism to pipe a trusted (let alone trustless) pricing index into the Bitcoin network from the outside, real world. As a result, if you are using a wallet service, you will have to manually adjust each transaction or wait until the wallet’s system administrator readjusts the fee-to-miner mechanism.
This creates more friction and delays in the user experience. For comparison, when you swipe your credit card at Walmart you don’t have to spend any mental muscle guessing how much it will cost Visa to process your transaction. Having to spend any amount of time on fee-estimate sites is an entire process that the average consumer is not going to bother with and doesn’t (as shown by the frustration with EMV pin usage in the US). What are 220 satoshis and why should a non-geek care that is how much it costs to send a transaction that is included into the next block?
If you’re interested, while the book shows its age in numerous areas (from August 2014), I wrote about a number of these same ideas above at length in: The Anatomy of a Money-like Informational Commodity.
See also:
- What is the “real” price of bitcoin?
- Unable to dynamically match supply with demand
- Are there changes in the volume of retail transactions through Bitpay this past year?
- A gift card economy: breaking down BitPay’s numbers
- A pre-post-mortem on BitPay
- If you were paid in a fixed bitcoin-denominated wages, your real income (before taxes) may have increased due to price appreciation as well. ↩