Yes, Bitcoin is volatile. But it’s still got defenders.

April 11, 2013

Bitcoin, everyone's new favorite online currency, has been on a wild ride of late, rising to a high of $260 per bitcoin Wednesday morning and falling to $63 per bitcoin on Thursday afternoon:


That's led to plenty of schadenfreude on Twitter, as people point out that these wild price swings all show that Bitcoin can't possibly function as a stable currency or useful store of value. (Justin Wolfers has been particularly scathing.)

But there are still plenty of defenders. And many of the defenses are quite interesting. Tim Lee, for one, points out that these wild Bitcoin swings have happened many times before. And Jerry Brito of the Mercatus Center recently argued that volatility didn't matter, so long as Bitcoin worked as an ingenious secure payment system:

Bitcoin will work as a seamless payment system so long as you can get in and out of it quick enough to mitigate volatility. That is largely a technical consideration, but it could also depend on the market’s liquidity, which conceivably could be hurt by speculative hoarding. I haven’t given this much thought yet, but given that bitcoin can be denominated down to eight decimal places, I’m not sure it will be a big problem anytime soon.

As a counterpoint, though, Felix Salmon thinks Bitcoin's volatility could undermine its usefulness:

Currently, it can take an hour for a bitcoin transaction to clear, which means that the value of the transaction when it clears can be radically different from its value at inception. Bitcoin only works for payments if you can be reasonably sure that its value will remain reasonably steady for at least the next hour or so.

Meanwhile, Tyler Cowen offers a really counterintuitive, tongue-in-cheek defense of Bitcoin. "Imagine you hold a currency which, over the next period will either double or halve in value.  The expected return of such a Bitcoin is in fact (0.5 x .5) + (0.5 x 2) = 1.25. What a good deal that is! Holding a single Bitcoin — a very volatile Bitcoin that is — seems like a lot of fun.  It’s unlikely that simple risk aversion will take away the expected gain there."

Then there are the Winklevoss twins, made famous by that Facebook movie, who turn out to have amassed "one of the single largest portfolios" of bitcoins around—some $11 million, or 1 percent of the $1.3 billion currency. They're mainly offering up the "just you wait..." defense. "At some point that narrative will shift to ‘virtual currencies are here to stay,’" Cameron Winklevoss told Dealbook. "We’re in the early days.”

And, finally, Ryan Avent imagines a future in which Bitcoin flourishes and volatility against the dollar is no longer a major concern:

The more transactions there are in Bitcoinia, the more entrepreneurs will want to hedge their exposure to foreign exchange volatility by paying suppliers or employees in the same currency they're accepting as payment. And Bitcoin wage payments reinforce the demand for goods and services that can be purchased with Bitcoins. The greater the ability one has to buy and sell what one needs exclusively within Bitcoinia, the less foreign-exchange volatility matters.

Whether Bitcoinia actually attains that critical mass is very much an open question, and I certainly have my doubts....  One might recommend a bit of macroeconomic management to create enough to stability to allow the critical mass to build, but centralised management is very much what Bitcoin is not about. Sceptical as Bitcoinistas may be of the value of central banking, it has developed as it has for a very, very good reason.

On the bright side, there are no doubt going to be some very interesting economics papers that come out of all this Bitcoin obsessing...

Related: Here's our simple, 60-second primer on Bitcoin.

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April 11, 2013

Bitcoin, everyone's new favorite online currency, has been on a wild ride of late, rising to a high of $260 per bitcoin Wednesday morning and falling to $63 per bitcoin on Thursday afternoon:


That's led to plenty of schadenfreude on Twitter, as people point out that these wild price swings all show that Bitcoin can't possibly function as a stable currency or useful store of value. (Justin Wolfers has been particularly scathing.)

But there are still plenty of defenders. And many of the defenses are quite interesting. Tim Lee, for one, points out that these wild Bitcoin swings have happened many times before. And Jerry Brito of the Mercatus Center recently argued that volatility didn't matter, so long as Bitcoin worked as an ingenious secure payment system:

Bitcoin will work as a seamless payment system so long as you can get in and out of it quick enough to mitigate volatility. That is largely a technical consideration, but it could also depend on the market’s liquidity, which conceivably could be hurt by speculative hoarding. I haven’t given this much thought yet, but given that bitcoin can be denominated down to eight decimal places, I’m not sure it will be a big problem anytime soon.

As a counterpoint, though, Felix Salmon thinks Bitcoin's volatility could undermine its usefulness:

Currently, it can take an hour for a bitcoin transaction to clear, which means that the value of the transaction when it clears can be radically different from its value at inception. Bitcoin only works for payments if you can be reasonably sure that its value will remain reasonably steady for at least the next hour or so.

Meanwhile, Tyler Cowen offers a really counterintuitive, tongue-in-cheek defense of Bitcoin. "Imagine you hold a currency which, over the next period will either double or halve in value.  The expected return of such a Bitcoin is in fact (0.5 x .5) + (0.5 x 2) = 1.25. What a good deal that is! Holding a single Bitcoin — a very volatile Bitcoin that is — seems like a lot of fun.  It’s unlikely that simple risk aversion will take away the expected gain there."

Then there are the Winklevoss twins, made famous by that Facebook movie, who turn out to have amassed "one of the single largest portfolios" of bitcoins around—some $11 million, or 1 percent of the $1.3 billion currency. They're mainly offering up the "just you wait..." defense. "At some point that narrative will shift to ‘virtual currencies are here to stay,’" Cameron Winklevoss told Dealbook. "We’re in the early days.”

And, finally, Ryan Avent imagines a future in which Bitcoin flourishes and volatility against the dollar is no longer a major concern:

The more transactions there are in Bitcoinia, the more entrepreneurs will want to hedge their exposure to foreign exchange volatility by paying suppliers or employees in the same currency they're accepting as payment. And Bitcoin wage payments reinforce the demand for goods and services that can be purchased with Bitcoins. The greater the ability one has to buy and sell what one needs exclusively within Bitcoinia, the less foreign-exchange volatility matters.

Whether Bitcoinia actually attains that critical mass is very much an open question, and I certainly have my doubts....  One might recommend a bit of macroeconomic management to create enough to stability to allow the critical mass to build, but centralised management is very much what Bitcoin is not about. Sceptical as Bitcoinistas may be of the value of central banking, it has developed as it has for a very, very good reason.

On the bright side, there are no doubt going to be some very interesting economics papers that come out of all this Bitcoin obsessing...

Related: Here's our simple, 60-second primer on Bitcoin.

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Brad Plumer | April 11, 2013