Friday, October 25, 2013

The still-curious case of Bitcoin

Bitcoin appears to be on another run, though it's hard to tell because it's also become considerably more volatile over the past couple of days.  Volume overall is thinner than it was in the last major run-up, which means even more likelihood of funny business in the price -- by which I mean behavior you wouldn't expect to see in something like a Dow or S&P 500 stock, not necessarily outright manipulation, though that's certainly not out of the question.

Clearly Bitcoin is something of value to at least some people, but what kind of something?

First, let's dispense with what Bitcoin is often claimed to be: an alternate reserve currency that could come to supplant "fiat" currencies like the dollar, euro, pound or yen.  Not only is its price hair-raisingly  volatile and its money supply tiny, so far as I can tell no one actually prices in Bitcoin.  People who sell things for Bitcoin figure out a price in a reserve currency and then convert to BTC at the going rate.  For example prominently displays its dollar-to-bitcoin exchange rate, generally substantially below MtGox's quoted price, and shows the dollar cost of every item below the BTC cost.  The dollar prices tend to be stable.  The BTC prices, therefore, not so much.

By the way, what is the Bitcoin money supply?  According to, there are currently about 12M Bitcoin in existence, which currently equates to around $2B.  That's a lot of dosh to you or me, but far smaller than the smallest measure of the dollar supply.  There are currently about 1.2 trillion dollars in circulation, and several times that not in circulation, stowed in checking and savings accounts and such.

It really only makes sense to measure the supply of a currency in that currency, so the BTC supply is currently about 12M BTC.  But which USD supply would that equate to?  I can buy stuff with money in my checking account without ever pulling out paper dollars, and conversely most Bitcoins in existence are not in active circulation, even if there's no formal notion of a Bitcoin money market account.  So probably we want to compare with the M3 money supply, basically anything that's in some account somewhere redeemable for dollars.  M3 is around $10T, or about 5000 times the supply of BTC at the current price.

It's actually pretty remarkable that something someone wove out of pure crypto could have that much value -- 0.02% of a major economy, but it's not really meaningful to multiply the current price by the number of Bitcoin in existence.  If, for example, someone tried to convert all 12M BTC to dollars in short order, that is, sell them, it's highly unlikely that the dollar price of Bitcoin would stay at its current levels.  On its most active days, MtGox was handling about 1% of that.  Flood the market with a hundred times peak volume and it's not gonna be pretty.  So who knows what those 12M Bitcoin really equate to.

The same issue applies, in theory, to reserve currencies.  What would it mean to try to convert the entire US money supply to Euros?  Nothing good, certainly.  But there's a difference.  Reserve currencies are regularly converted, directly, to real goods and services.  We can therefore compare, say, the price of an hour of labor in the US to an hour of the equivalent labor in the Eurozone and get at least a rough cross-check on the relative value of the two money supplies.

But enough amateur economics.  What is Bitcoin?

There would seem to be two major possibilities:
  • An anonymous online payment system.  If I want to buy something online anonymously, I can convert money to Bitcoin and send it to the seller, who then converts it back to money.  Though each Bitcoin transaction, by design, is public knowledge, only the exchanges know which real money accounts are involved, so as long as they're not paying attention, or hacked, or subpoenaed or such, there is no way for the seller to know who I am (There are designs for layering real anonymity on top of Bitcoin, to the extent that it would not be possible to tell which particular person participating in the scheme owned a particular Bitcoin in the scheme, but as far as I'm aware no one's actually doing this).
  • A speculative vehicle.  It's possible to tell unambiguously who made what Bitcoin transaction, and therefore who owns how much Bitcoin, with the understanding that "who" means "the holder(s) of which private key" and that it's at least theoretically possible for someone or someones with enough computing power to hijack the whole system.  Leaving that aside and thus assuming there's clear ownership, Bitcoin can be traded just like baseball cards, sparkly pieces of rock or mortgage securities.
Ideally an anonymous payment system would maintain a stable exchange rate between the tokens of payment and actual money, but as long as the exchange mechanism is fairly liquid, and the total amount given up in the money - token - money loop is not too much, people will continue to use it, and it appears that people still do.

On the other hand, a speculative vehicle doesn't even require that much.  It only requires that something can be bought and sold and at least some people want to buy and sell it.

That would make sheer speculation the simplest answer.  One crucial question is, how much of the volume in Bitcoin trading is from Bitcoin as a payment system, as opposed to trading Bitcoin for its own sake?

In the last couple of months, daily volume on MtGox has varied from around 5,000 on slow days to twenty times that during major selloffs.  Trading resulting from conversions for payments ought to be fairly steady over the short term, or in other words, it's probably not more than the minimum daily volume, and it's probably less.

That leaves quite a bit of room for speculation.

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