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Bitcoin Crashed. Again.
When writing about economics (as opposed to trading), one does not expect to be proven right within days of publishing something. Things can take years to play out. On Monday, February 25, we published What Drives the Price of Gold and Silver? In that article, I wrote:
If there is a credible rumor that the Fed is planning to further extend its “Quantitative Easing”, how would you expect the monetary metals to react? Typically, the gold price would rise and the silver price would rise even more. The question is why.
Traders read the headlines and they know how the price “should” react to such news, and they begin buying. For a while, the prophecy fulfills itself. But then what happens next? It may take an hour or a month, but sooner or later some of the new buyers begin to sell. What can be bought on speculation using leverage must eventually be sold.
On Tuesday, Fed Chairman Bernanke testified before the Senate. Sure enough, the prices of gold and silver rose sharply. The next day, the prices were back down. By Thursday the price of silver was lower than it had been prior to his announcement.
On March 3, we published a video asking Is Bitcoin Money? While I appreciate many aspects of the cool technology behind it (being a software developer in a previous career), and noting that it has several features that uniquely suit it for certain markets, I concluded that it is an irredeemable currency, but not money (i.e. the most marketable commodity). I received much feedback on the video, some of it negative, though mostly thoughtful and engaging.
At the time of the video, Bitcoin was trading around under $40. Since then, it rose to about $48.
I was surprised to read that yesterday it fell to a low of $37. It has mostly recovered though it is now a few dollars below its high of $49. What happened?
The technical term is that the “blockchain forked”. In the video, I was very careful not to criticize the digital currency on technical grounds such its cryptographic technology, peer-to-peer networking, its data formats, methods of validating transactions, or communications over Internet Protocol, etc. I wanted to keep the discussion about monetary science. There is a point that I could have made, and will now make here.
If a currency is subject to Internet availability or other technological considerations, it simply is not money. It may still be useful for enabling commerce that would otherwise not be feasible—this is not an attack on Bitcoin as such. But (at least) one key characteristic of money is missing. Money must be beyond question by everyone and at all times. By nature, gold never becomes “unavailable” (though one could entrust it to an institution that suffers from unavailability of course).
When its “blockchain forked”, Bitcoin’s essence was called into question. Suddenly there were possible competing claims to the same coin, possible loss of coins, and certain lack of availability of the currency at least until engineers fixed the problem.
It has crashed before, too. On August 17, it moved from about $15.50 to $10.50 in a few hours. There were previous crashes before that, and there will likely be more (no this is not a prediction for next week!)
Technology aside, there is another factor that contributes to so-called “flash crashes”. If there is a wide bid-ask spread and/or the stack of bids is sparse, then it does not take much selling pressure to cause the price to collapse. For purposes of this discussion, let’s focus on the. While it is possible for the price to rise explosively, there is an important asymmetry between bid and ask: in times of extreme stress, it is always the bid that is withdrawn, never the ask.
Imagine if the US Geological Survey said that there would be a massive earthquake in Los Angeles, estimated to be 15 in the Richter Scale and which would not leave anything taller than a fire hydrant standing. There would be no lack of offers to sell real estate. What would be gone would be the bids. Anyone who needed to sell would have to accept peanuts, if he could even get that.
As I pen this, late Tuesday evening, I see a bid of $45.02 and an ask of $45.1377. This does not seem that bad, $0.1177 spread or about 26 basis points. But the bid looks thin to me! At $45.02, there is around 600 bid.
This is a screen capture I just took from Bitcoincharts.
$600 X $45 = $27,000
There is about twice the depth a whole DOLLAR lower. And then again there is another 1200 or so bid a bit lower than that. Even assuming that there is little liquidity at 1:30am EST, this is not a picture of a highly marketable good, much less the most marketable good. One lone trader who needs to sell $100,000 worth of Bitcoin could drive the price down about 2.5%.
To put this in perspective, a copper future is 25,000 pounds and copper is currently $3.55 per pound. One copper future is worth almost $90,000. I am reasonably certain that selling a copper future (or 10!) at this time of night would be but a small blip. In fact, in a few seconds, I watched the May copper future trade 25 contracts, or $2.2M. Copper is not money, of course.
So what’s the take-away?
Bitcoin is still apparently a great trade—a speculation—as it has risen more than 12% even from when I recorded that video. Bitcoin is still useful for certain transactions particularly across borders, and especially for those people unfortunate to live in countries with censorship, capital controls, or in which some kinds of goods are prohibited.
But it’s not money. It is not the good to hoard as the core of one’s savings, if one does not like the rate of interest or trust the banking system or feel comfortable about the future.
The good for this purpose remains gold.
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The small fork that happened yesterday is a good example of what would happen is someone decided to change these rules.
It would create another blockchain (think ledger book) based on the new rules , while people who agree on previous rules would still have their own.
People would be free to decide which one to use
> The supply of Bitcoin is limited as long as its creators don't create anymore.
A mathematical impossibilty at this point unless the protocol was somehow changed. But if the protocol was somehow changed, everyone would leave the network and Bitcoin would have no value.
21 million is written in stone.
Just to be clear the software source code could be changed by anyone to allow more than 21 million. However, almost no one who uses the software would ever accept or run such a changed version of it.
Why? Because it would immediately result in all their holdings of Bitcoin losing their value due to market forces. Game theory says that all participants work in their own self interest and thus, the users of bitcoin and especially the miners will never willingly agree to such a change unless someone can convince them otherwise.
Feel free to try!
Very good explanation.
My big problem is this. Anything artificial, created by someone, can be distorted and manipulated.
I have gone through the bitcoin fax sheets. I know of the limited quantity. I also read their warning of severe deflation because of that.
But I have always been concernec that the originators of bitcoin might manipulate and destroy the bitcoin market by doing such things as, creating unknown bitcoins for themselves.
Under the bitcoin explanation, an algorithm is used that would limite bitcoins to about 21 million. Well algorithms can be changed. Who monitors this? These are digital can can be created out of thin air just like fiat currency. Why wouldn't it be something that a person might want to exploit?
an algorithm. that cinches it. why would anyone do this. its monopoly money, and even the monoploy money rules say the bank never runs out it can just create more.
A changed algorithm wouldn't play with all the others. Such a thing could be Bitcoin B, but never Bitcoin.
There is no central handle to be grabbed, manipulated or controlled. BTC is DISTRIBUTED.
Everyone, whether they use bitcoin or not, can see and hold a copy of the ledger. The ledger verifies all transactions between addresses, but does not reference who has which address. You can create (as far as I know) as many addresses as you want to obfuscate large transactions.
If there is a conflict between copies of the ledger, whichever copy is most distributed becomes the official ledger. If there is a divergence, like what seems to have just happened, then whichever version has the most processing power wins, although in this case the people just "sat down" together and worked out a solution, rather than fighting it out with processing power.
It's designed to have disinflationary supply growth and it deosn't involve a bank as a middle man, ie it's p2p.
I totally agree with your other points.
The biggest problem imho is the deliberately disinflationary supply growth (which is limited at 21 mill. BCs and growth rates are cut in half every 4 years). That's rewarding the early users and causing automatic appreciation. That's not what a free market whithout entry barriers looks like. It doesn't make sence to spend BCs therefore, because they're designed to gain in USD price. Gresham's law will be proven right again.
The same is essentially true of silver and gold. The supply is limited (though the limit is not explicitly known) and the growth rate ofproduction is declining. Your conclusion that such is incompatible with a freemarlet without barriers is a non sequitor.
Annual Production for gold and silver is not declining. It's close to all time highs.
http://www.goldsheetlinks.com/production2.htm
But the grades of ore ARE declining; diminishing returns. Do you really think exponential growth in gold production can continue indefinitely?
Not indefinitely, but I think we'll run out of other ressources first. The gold mining industry needs higher exploration sucess rates. Something like what 3d seismic was for oil: http://en.wikipedia.org/wiki/Reflection_seismology If we manage to get space mining going during this century (87 years to go), we'll probably never have shortages of gold. The key for that is to reduce the cost of getting tonnage into a geostationary orbit.
You know what the most interesting part of your post is that probably most missed?
"It doesn't make sence to spend BCs therefore, because they're designed to gain in USD price."
Do you realize that you are saying that the value of the bitcoin is relative to the USD?
This is more then Gresham's law. Bitcoins are designed to be a competing currency like a foriegn currency.
The whole point is that they won't compete as mediums of transactions, because BCs will appreciate which makes it irrational to spend them if you can spend trash instead... They'll serve as a store of value to a degree, but they won't be spent on a broad scale. So they're also not in direct competion to the USD, because the USD is a lousy store of value, but a great medium of transaction due to abundant liquidity. The strenghts and weaknesses of the two are diametrically opposed.
People who spend $30,000 on a mining rig likely will not wait 100 years for the price of bitcoins to max out. Many of them will need to turn over at least a fair portion of their bitcoins into dollars, to recoup their Cap Ex and operating expenses.
It's sure nice to see your savings increase in value, but at some point, you have to eat or you die. Sure, this is an extreme example, but there's so many others.
Deflation is false problem.
Don't forget it tags the user with that New Age "small" trasacution fee for using it. Just another way of enslaving one with interest.
Until the component of charging someone interest to use one's own money supply is taken out of the equation, people (Global Criminal Elite Cabal Crime Syndicages) will continue to enslave mankind with Wars and debt Slave bondage.
I hear what you're saying but.... Can't we say the exact same thing about gold?
Is gold designed to gain in USD price, or is that just a symptom of being finite?
Didn't the gold miners in 1949 also get early rewards, which you and I do not benefit from?
Gold buggery is my middle name.... but I'm also an early BTC adopter. FWIW.
Yesterday I went to localbitcoins.com. I bought 7 BTC for $47/per. $330 total. From a guy in Ithaca, NY.
Now I'm paying a web designer 7 BTC to implement a shopping cart on my web site so we can sell my girlfriends pottery online.
www.colonialinntheglen.com I built the web site up to this point but I can't implement a shopping cart.
No CC fees, no reporting on the transaction. Just some trust developed between two humans who voluntarily associate and trade.
All the theory and jargon aside, admittedly most of it is way above by pay grade, BTC is working as a medium of exchange for me.
I've thought about that point, too.
However, the world gold supply is not growing in a disinflationary way. It's growing in an inflationary way due to production growth: http://www.goldsheetlinks.com/production2.htm The fact that prices have risen over time also helped miners staying profitable. Currently, there isn't one mine on earth with a cost structure at $35 or less. In fact, the sidewards trend of the last two years has compressed margins, because costs have continued to rise: http://www.pmbug.com/forum/f14/paradigm-shift-pm-mining-industry-growth-...
I don't think that the cost of mining bitcoins has increased so far.
Swiss, I went over and read your analysis, great stuff. Only place I'd differ is in the theory that SLW etc are the big winners. Paper promises, et al. Legal, schmegal, no metal, no delivery to said hedgers. Thoughts?
I agree that they have claims on future production. These are claims on paper. But they're receiving actual metal, not 100:1 levered COMEX futures contracts or unallocated LBMA claims. If we'd get a physical/paper spread, they'd be getting the physical price imho. It all depends on whether the rule of law would still exist then or not - as you said. If it doesn't, regular miners would be effed, too. A mining operation is dependent on multiple suppliers. If their supply chain were to break down and contracts were no longer enforceable, they'd all be forced to shut down, too.
You're probably right in your comments about gold. I'm only smart enough to know it was a good move to get out of fiat back when gold was at $975 and I've been sleeping soundly since. The last year or two of gold prices has woken me up to the nature of the paper gold market. Unfortunately I really can't address your points about gold. I'm just not that smart.
The costs of mining btc are 1) a machine that can mine profitably, 2) electricity.
If miners don't continue to invest in #1 theyre mining operation will become unprofitable and the amount of bitcoin they mine wont even be enough to pay the electricity bill. #2 is a fairly stable cost.
I'm not sure if #1 fits our definition of "increasing cost to mine BTC". But I can tell you that early BTC miners were able to use their laptops (CPUs) for mining operations. They mined enough BTC to cover the cost of electricity and earn a small profit. Then due to the increasing difficulty of mining (more on this later), they had to buy newer mining rigs with GPUs. The miners that didn't upgrade their equipment, invest in better machinery, fell behind and their mining operations on the CPUs became unprofitable. Because of the difficulty of mining they didn't even mine enough BTC to pay the electricity cost of running their CPUs as a miner. In my mind this is like a gold miner with a shovel and pick trying to work a pit mine next to a couple heavy duty loaders and some chemical method of collecting the hard to get gold. Now the GPU miners have to upgrade again because these ASICs are coming online. If a miner tries to compete against the asics, theyre just going to be wasting electricity. Again the pick and shovel guy who can mine 1oz of AU a year just wont be profitable when the guy with the bucket loaders is making 10oz of AU available on the market every day.
So as I see it miners must invest in capital to stay profitable. I believe that does mean the cost of mining is increasing. Or at least there are ongoing expenditures to stay profitable. Also, I'm not a computer farm expert but these mining rigs need to stay cool. These mining rigs need to be secured against physical or digital attack. Miners must stay abreast of the softwares that make mining more efficient to stay competitive and profitable. Miners have to mine at least enough BTC to cover their electricity costs or eventually they go bankrupt. Although, because the entry barriers are incrediably low at this point, many CPU miners are still willing to let their laptops consume electricity in the hope they will solve a block and get a btc reward. But like any venture, if they lose money long enough they eventually go bust. In this case bust just means one less pizza every month. :)
yes? No? I'm not really sure.
Very much like gold: people used to be able to mine nuggets with picks. Now, you need to move a ton of rock to get a few grams. Gold is deflationary; it's just hard to tell, with the USD losing value so quickly. Once we get over the peak in oil production, I'm sure we'll see some big changes in gold.
The cost to mine bitcoin has certainly increased. This is due to both the increase in competition as well as the scheduled drop in availability. You used to be able to mine bitcoin with any PC that was running. Now to try and make a profit you have to have high powered machines, join a mining group or steal power from your neighbor
In my book, if it needs electricty to survive or use, IT AIN'T SECURE.
If your premise is a future that consists of no more availability of electricity and thus no internet (return to the stone age?), then you are quite correct.
The great Bit Con.
Many people are going to be very sorry they ever bought into this ponzi pump and dump.
yes indeed 500% in 2 years means many people are very sorry they never bought into this ponzi pump and dump....
VIZ!
Sell your Beanie Baby coins while you can realize that profit...and put it into gold.
Buy pretty tulips with your bit cons while you can.
yes keep talking your book.. i am in pm's but am most pleased with my early adoption of btc and have huge respect for the open source movement, take a long hard look at the honesty and transparency they bring to technology.. then look long and hard again... cause if there is a future these unix geeks are leading the way..... remember necessity is the mother of invention ... btc is the only real competitor to fiat in the online market place.... with no disrespect for pm,s being the safest in terms of store of value.
silver, gold and bitcoin bitchez....
and bitcoin will be mega volatile as it grows its base as a fledgling technology..but will it go away ,... no way hosey...
Fiat is 1% money still being fractionalized every month by fucking Bernanke. Everything now is money...except money. We are so far down this debt shithole that 'money' is what you flee from, not to. I feel more confident now that a post-flash crash Bitcoin recovery looks better than a HFT flash crash in equities.
Fiat is fraud - nothing more.
If you cant hold bitcoin in your hand it's fraud too.
Get over it.
You can hold bitcoin in your hand.
WRONG. You hold a checkbook. The checkbook is a flash drive with a record of account. It is a bank balance sheet, although with the reservation that you are the bank.
10 bitcoin physical coin made out of one troy ounce .999 silver:
https://www.casascius.com/
EDIT: although technically a 100% reserve backed coin, it also has the inherent value of 1 ounce of silver.
I hate to inform you fiat is not fraud. The entity or person guaranteeing it's value is the source of trustworthiness or fraud. The fiat is just a representation of it. Fraud is a symptom of a human problem which is a moral one. Centralized trust is even worse because it allows for a choke point where the saying one bad apple spoils the whole bunch is a high probability. Decentralized fiat lowers that probability and deals with that basic human problem.
Wasn't this the Honorable Milton Friedmans position. He wasn't against paper currencies or central banking, in fact he was in favor of them both. But he said something like "it's not the fiat paper and centralized system that fails, its the humans who can not resist inflating the paper currency"
*Chuckles*
Hate the sinner, not the sin.
Cheating= If it can be done...it will be done.
Human Action. (bitchez)
Just like bitcoin you can't eat your PM's either.
Winning.
Bitcoin can be a partner with precious metals. Many people are doing just that. I understand if you think the risks are too high and choose to abstain.
We're on the same side here, honestly.
I actually just bought my wife a gift with bitcoin recently. More and more businesses are accepting it. Found some nice items here:
http://www.allthingsluxury.biz/
The old "currency vs. money" issue. Butcoin, like fed paper, is NOT money because it is not a store of value over time. They are both currencies. Bitcoin has piqued my interest, but I don't know enough about it to buy it. PMs are money and have been for thousands of years. I don't see that changing soon.
I sure hope Keiser doesn't blow his cred with bitcoin. He's an insider that understands what goes on in Wall Street and has a knack for explaining it to financial simpletons like me.
Bitcoin in concept is awesome. In practice, it's totally busted and high-risk.
One problem is the size of the entire market is only ~$500 million, which means that any hedge fund (or uberwealthy individual) that wants to corner the market or manipulate the hell out of it, can. Gold and silver are far bigger markets and those can easily be manipulated by the powers that be. Bitcoin by contrast can be manipulated with a couple million. That's hardly a secure currency.
A far bigger problem is security. Despite all the "it's 100% secure" guarantees, it just isn't. Mt. Gox has now been attacked (successfully) twice. There are countless accounts of scams, thefts and hacks to the ownership lists which are vital to the chain of ownership. The response to this invariably is that you have to be careful and know what you're doing. Well... guess what, most people aren't adept at online security and if mass market acceptance depends on the market suddenly acquiring security expertise then you've got a long wait ahead of you.
Thirdly -- it's 100% traceable by definition. Because all bitcoin ownership is stored across a p2p network (along with all transactions) for the sake of security, it also results in 100% traceable currency and transaction records. How is that any better than say, Citibank?
And lastly -- despite a few high-profile sites and online stores starting to accept bitcoin payments, it is not a liquid currency by any means. I'm sorry but there's only so much you can possibly spend at Wordpress.com -- how are you going to spend the rest of your bitcoins? If the answer is: Well, first you have to trade them in for dollars... well then... that's not a currency its a pyramid scheme.
What's most pathetic is that bitcoin promoters (like Max Keiser all of a sudden) are invariably "talking their book". Once people buy into the pyramid scheme, they suddenly become cheerleaders for their own assets. IMHO Keiser is rapidly losing 100% of his credibility as he abandons silver and begins shrieking about what is fundamentally an insecure, high volatility "non-store" of wealth.
Yeah,Bitcoin is cool since the CIA originated the concept.............so it can ultimately suck more people dry.
I'm tired of this nonsense. In particular, I'm tired of the notion that a "big player" can have its way with the market, or any market.
While it's true that a major holder of bitcoins can crash the market by selling, or a major holder of other assets can pump up the market by buying, that in no way implies any advantage for the major players. Ironic and counterintuitive as it might seem, the fact that major players have so much influence over the market is precisely what robs them of their power!
Think about it like this. Let's say one person owns 25% of all bitcoins that have been issued. On paper, his wealth amounts to one quarter of the entire market cap of bitcoins. Let's say this one quarter amounts to $100 million. However, this number is complete fantasy. In no conceivable way could he obtain $100 million by selling his bitcoins. He might be lucky to fetch $1 million.
That's because he can only sell to the extent that others are willing to buy at the time. The instant he oversaturates the market, his already illusory wealth vanishes in front of his own eyes. Current market prices are based on past market activity, and are completely dependent on the fact that selling activity is low!
A more realistic scenario goes like this: The holder of 25% of all bitcoins wants to liquidate his holdings. He goes ahead and sells the first 1% of his holdings, fetching an average of 1/2 the prior market price. The next 1%, he sells for 1/5 the market price. The following 1%, he gets 1/20 the market price...
The major holder has only been successful in selling 3% of his portfolio, and in doing so, the remaining 97% has lost 95% of its value!
It works the same on the way up. Each million dollars he spends buying bitcoins sends the market multiplying in value several times over.
A major holder, knowing how much influence has over the market, would have to be an idiot to use that influence in any way!
This demonstrates why "the market", as defined by the current going price, is ONLY relevant to small-time buyers and sellers. It also demonstrates why the major players have far LESS power and relevance than people assume.
This explains exactly what the valid purpose of algorithmic trading should be: to spread out large orders over hours, days or weeks to prevent the order from moving the price.