Since my last post about Bitcoin, the price of one bitcoin has plunged from highs of around $240.00USD to $69.98 at the time I am writing this on April 16, 2013. The day that the panic-selling began was April 10, 2013. While the price has obviously changed drastically, what about Bitcoin itself? Surely this massive sell-off must have been caused by eroding confidence in the strength of one or more of the four fundamental factors that help determine the price of a bitcoin? To further examine these questions, let’s reexamine the market fundamentals:
- The number of bitcoins available
- The number of people in the market buying and selling bitcoins
- The security of the Bitcoin network
- The market’s understanding of the above factors and how they affect the price
Changes in any of these fundamentals can greatly effect the others, and will cause the price of bitcoins to go up or down.
I said in my last Bitcoin post that I believed the fundamentals affecting the rising price of bitcoins were much stronger this time around than during the crash of 2011. It has been nearly 2 years since that crash, plenty of time for potential market participants to read up on Bitcoin and understand its utility and determine whether or not it was valuable to them. The mainstream media has been running stories about Bitcoin almost daily, and educationally/technically speaking they have been improving as more journalists “get it.” I posited that as long as the security of the Bitcoin network itself – I called it the “foundational fundamental” – remained sound, people would not lose confidence in Bitcoin and the number of people in the market would therefore continue to grow with the increasing interest in Bitcoin. While my confidence in Bitcoin itself remains unshaken, my confidence in the major exchanges that facilitate trade is shaken. Mt. Gox, the largest Bitcoin exchange, pulled itself offline for 12 hours, accelerating the drop in price, and a truly reliable and liquid trading platform has yet to be created. I still believe that the security of the network is the foundational fundamental which gives Bitcoin utility and value – after all, breaking the security would make it virtually worthless overnight – but I would also like to reiterate that it is the fourth fundamental which has the most drastic effect on the actual price of Bitcoin. The psychological aspect of the Bitcoin market is what sets the price, not simply the utility of Bitcoin. After all, the Bitcoin protocol has remained more-or-less the same since the program was first released, yet we have seen the exchange rate go from 10,000 bitcoins for a couple pizzas to $240 for a single bitcoin in less than 3 years. What has changed since then is only people’s perception of Bitcoin’s intrinsic (and actual) utility; whether or not a digitally scarce medium of exchange that is part of a distributed, decentralized payment protocol which offers irreversible, pseudonymous, near-instant global trade is valuable to them.
What occurred during the crash last week was a massive sell-off caused not by a glitch in the system or an unpopular change in the Bitcoin protocol, but rather a very simple market reaction to steadily climbing prices. Speculators who were increasingly interested by the prices which seemed to have no ceiling – $35 in early March, $50 by mid-March, $100 by April 1st, $150 by April 7th, up to $240 overnight on April 8th – were doing what all speculators try to do: buy low and sell high. Some have a set formula, others go off of feeling, but during such a meteoric rise many probably set their sell threshold low – a 20% – 50% rise in price was all that was needed to signal it was time to sell. While the media had been putting out about one major Bitcoin story every few days in mid-March following the quick rise from $30 to $50 to $80+ caused by anxiety about the situation in Cyprus, the attention grew into a media frenzy when the price hit $100 on April 1st. This leads me to believe that many of the speculators were people who already had approved accounts on the major exchanges, and capitalized on the frenzy by attempting to drive the price upward. It worked, drawing even more attention to Bitcoin, and bitcoins very quickly passed the $200 mark. A switch went off in the speculators’ heads as their price threshold was reached, and they quickly began selling. They continuously sold under the market price in order to make a quick sale, thus setting off a dramatic race to the bottom.
While “true” Bitcoiners hung on to their coins (or perhaps sold just enough to cash out their initial investment while they still could in the short term), the speculators all but left the market entirely, returning the price to a more sustainable level as seen before the “$100-per-bitcoin / billion dollar market cap” media frenzy. The price has yet to find equilibrium between supply and demand – it has risen almost $5 to $74.47 since I began writing this post – and because the market is still small compared to other asset classes, this volatility is not likely to go away until a strong growth in the number of market participants occurs. Mt. Gox said in a blog post shortly after the price drop that they were receiving 20,000 new account applications PER DAY. Whether or not this is still the case, I do not know, but I have to wonder what those new account-holders will do once they’re cleared to trade. Will they abandon interest in Bitcoin, or be glad that they have a chance to buy low? Only time will tell, but I remain confident that we are still at the beginning of a Bitcoin boom.
More people are aware of its existence now than at any previous time in Bitcoin’s history, and this will lead to more becoming true believers in its potential to change the world for the better. The price has definitely “crashed” from its high of $240, but relative to the price before the dramatic rise, we have still seen incredible growth: it is trading up over 100% of its price just two months ago. That’s quite impressive for any asset class, and once those “20,000 new accounts per day” are approved on Mt. Gox, we may see a large influx of traders and long-term investors. The Bitcoin protocol is still sound – there will still only ever be 21 million in existence, and it will take about 130 years to mine the remaining half of the supply – which makes bitcoins a scarce commodity, and thus valuable to those who, at the very least, find value in its utility as a pseudonymous, irreversible medium of exchange.
As the market forges through its growing pains, creative methods of decentralized trade will be devised to route around the central points of failure in the current major exchanges. Already, OTC (over-the-counter) markets like Bitcoin-OTC and localbitcoins offer p2p methods of trading bitcoins. Ripple, Open Transactions, and Vendor Relationship Management technologies have a lot of potential for increasing the number of decentralized exchange platforms, and one Redditor “enki23″ recently announced that he/she is working on an open source exchange platform dubbed “Buttercoin” in order to increase the number of exchanges available, further distributing the trade network. Solutions are on the horizon, and the markets will quickly decide which work and which do not. The bottlenecks which have occurred in the major exchanges are proving that the current, centralized way of doing things isn’t working for this market. I can appreciate the amount of trade volume and liquidity that the major exchanges facilitate when they’re working well, but when they fail, they fail spectacularly. This is a hallmark of centralized systems, and is why Bitcoin itself was designed as a distributed payment protocol in the first place. Decentralized, free market currency deserves decentralized, free market exchanges.
I look forward to the day when I can push an order out into a decentralized, p2p order book and receive responses from trusted people all throughout the network and have coins deposited to my account within minutes. This day is not far off – just check out the projects I linked to above. Yes, the future is bright for the Bitcoin ecosystem. We as a community just have to support the projects that are creating the services we want and continue to innovate so that Bitcoin is accessible to the masses. I said it at the end of my last post and I’ll say it again because I still believe in Bitcoin, and know we’re just at the beginning of a steep adoption curve: Welcome to the Bitcoin boom of 2013!
Disclosure: author is long bitcoins