What The Government Cant Do For You: Bitcoin

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Wednesday, April 17, 2013

Bitcoin: What Has Changed?

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.

Peer to Peer Crypto-Currency Bitcoin

by John Light
p2p connect
April 18, 2013

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

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Bitcoin: What Has Changed?

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.

Peer to Peer Crypto-Currency Bitcoin

by John Light
p2p connect
April 18, 2013

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.

Disclosure: author is long bitcoins

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Bitcoin: What Has Changed?

Thursday, April 11, 2013

POP! Bitcoin Halted

The ongoing Bitcoin correction (or crash) which Brotherjohn (whose silver market analysis we highly respect) referred to as “a very normal looking market” in hisBitcoin report on Wednesday night, continues.

SGT report reader Vision Victory reported seeing a low print today of $ 55, with trading in Bitcoin now halted. Primary Bitcoin exchange Mt. Gox announced the halt in trading and provided this rationale: “Trading is halted until 4-12-2103 at 2:00 am UTC to allow the market to cooldown after a drop in price.”

Indeed. With no NYSE circuit breakers in place, the popping of the Bitcoin bubble was sure to be fast and furious as Chris Duane, Mike Adams and so many others have been warning. We see current prices for the crypto currency hovering in the $ 75 – $ 100 range.

anatomy-of-a-bubble

Delivered by The Daily Sheeple

Contributed by SGT Report of www.SGTreport.com.

The Daily Sheeple

POP! Bitcoin Halted

Wednesday, April 3, 2013

Gold, Redeemability, Bitcoin, and Backwardation

I recently released a video about the Internet-based currency, Bitcoin. I asked the question: is Bitcoin money? In brief, I said no it’s an irredeemable currency. This generated some controversy in the Bitcoin community. I took it for granted that everyone would agree that money had to be a tangible good, but it turns out that requirement is not obvious. This prompted me to write further about these concepts.

A human being has a physical body with physical needs, and lives in a physical world. He produces that he may eat and clothe and shelter himself. Once civilization develops beyond subsistence, men specialize to increase their production. Each relies on others, who specialize in other fields. Each trades his products for the goods produced by others.

A problem arises, called the coincidence of wants. One man produces food and another produces leather moccasins. When the moccasin producer is hungry, the food grower may not need new shoes. Mr. Moccasin must discover that some goods are more marketable than others. He can trade less-marketable moccasins for more-marketable salt, for example. He may not need the salt (though he can always use it) but he knows it is accepted in trade for food and other goods.

Eventually, a market process finds the most marketable good. It becomes even more marketable due to its increasing use as money (but it does not lose the attributes that made it useful in the first place).

People accept the monetary good in trade because it fills one of three needs. They will exchange it for something else later. They may want it for its own sake. Or they may accumulate a hoard during their working years so that in retirement, they can dishoard to pay their bills.

Modern civilization layers a complex financial system on top of the monetary good. It has bills, bonds, and savings accounts, etc. Most people do not want to redeem most paper credit instruments, for reasons of convenience and the preference for an income. However, it is important to keep in mind that the possibility of redemption is necessary and essential to a working financial system. Everyone must choose for himself the right balance between holding the monetary commodity directly and various earning assets that promise to be redeemed in a quantity of the monetary commodity in the future.

Only this balancing process can perform one particular and critical function. Hoarding, also known as managing risk, has played a vitally important role throughout human history (and which is almost unappreciated by the economics field). Hoarding and investing are balanced by risk tolerance. In a free market without central banking and bailouts, everyone must think of risk.

To the economist, redemption of paper and hoarding of the monetary good, serve to police and clean the system, force the write-offs of bad credit (as opposed to letting them accumulate), and of course empower the saver to enforce his interest-rate preference. This last, is a point that I have not seen anyone make prior to Professor Antal Fekete, and which is under-appreciated today.1

To the hoarder himself, hoarding looks and feels very different. He is thinking of having something tangible in hand. A coin in his pocket does not have a risk, it can be carried anywhere, and can be accumulated in a safe place. To anyone aware that he is living in the physical world, there is no substitute to having a physical, tangible commodity.

Today, of course, legal tender laws obscure most of the above. The monetary commodity is not allowed to do its job, and we’re lucky that after they removed it from the monetary system they at least once again legalized its ownership for American citizens. Even so, most people regard owning gold as a risky speculation because its dollar price is volatile. It’s madness.

Returning to the question of Bitcoin, we have a conundrum. Bitcoin is not debt. In that sense, it is like gold—there is nothing to redeem because the thing is the final good. Unlike gold, it is not a tangible good. You cannot hold it or stack it in a safe in the floor. Other than the value you hope it has in trade, it has no utility by itself.

Bitcoin in this context is like an attempt to reverse cause and effect. Gold is money because people strongly desired it for its physical properties and then, subsequently, discovered that it was the most marketable good and thus useful as money. Bitcoin bypasses this and attempts to go straight to being money. Should hackers break its cryptography, the Internet go down for a few months, or any number of other scenarios occur, the above logic will reassert itself.

Owning Bitcoin is to be in a partially completed transaction. Until it is exchanged for a tangible good in another trade, the owner of the Bitcoin is in the position of having given up something tangible for nothing in return.

I made the point, in a previous video that redemption is not the same thing as purchasing the monetary commodity. Prior to 1933, one could go to any branch bank of the Federal Reserve and exchange dollars for gold. This was not “buying” gold, but redeeming the dollars. One accepted the dollar bill in trade, with the sure and certain knowledge of the terms (e.g. gold value) of redemption. Unlike then, today the dollar can be used to buy gold. But there is no way to know the terms—or indeed if one can even make the purchase at all—until one attempts the transaction.

It is the same with Bitcoin.

Now that I have used Bitcoin as the foil to establish several points, let’s look at the dollar and its ability to buy gold. Consider the following points that I discussed at greater length in this video:

irredeemable debt-based currency provides no way to extinguish a debt

the dollar itself is a debt instrument

payment in dollars merely transfers the debt

all debt is borrowed at interest

eventually, the interest cannot be paid out of income

the only way to pay the interest in aggregate is further borrowing

total debt in the system grows exponentially until it cannot

The system is designed to drive all participants to bankruptcy! “This is,” as they say in technology industries, “a feature, not a bug”.

In this light, the problem is not the rising quantity of dollars per se (though endless issuance by the Fed is certainly not good) but its falling quality. It is all headed to default when the debtors cannot borrow any more. This point was reached in Greece, but it is years away in the United States.

One might be tempted to ask why the banks and financial institutions don’t recognize this and refuse to do business in dollars. The answer is that they are regulated, they ultimately answer to investors who believe in dollars, and they are given perverse incentives to continue to play the game. For example, they can borrow short at near zero from the Fed, and lend long at near 2% to the Treasury. This transaction creates no wealth, but the banks engaging in it earn “profits”. They are fat, dumb, and happy to make this spread and many others like it.

So who understands it? The lowly gold hoarder does. His challenge is that he is sometimes distracted by the mainstream message that gold is a risky commodity that cannot be used to buy bread. He is often distracted by the goldbug message that the rising gold price is a “profit” (and the falling price is a conspiracy). If he can see through these two mirages, then he can see that all the credit in the system must inevitably and inexorably crash to earth like too many rocks impossibly kept aloft for a while by a juggler who exceeds his limited skill.

“Money is gold and nothing else,” as JP Morgan famously said in testimony before Congress. When bad credit eventually is repudiated, gold will still endure.

This is the context to my argument: permanent gold backwardation is a late symptom of the terminal monetary disease. Like jaundice in a cancer patient, signaling to the doctor that the patient is in immediate risk of death by liver failure, permanent backwardation signals to the economist that the monetary system is in immediate risk of death by gold withdrawal.

The dollar is not strictly redeemable, but it can still be used to buy gold. This provides an “escape valve”. Those who wish to convert their irredeemable paper into the monetary commodity, to complete the transaction of trading their product for dollars and dollars for the monetary commodity, can still do so.

Backwardation is when the price of a commodity in the futures market is lower than the price in the spot market. Anyone who has the commodity can make a profit by simultaneously selling the commodity in the spot market and buying a future to recover his position. This trade has no price risk, credit risk, or even spread risk. The only risk is default. Permanent backwardation is when all futures contracts fall below the spot price, and the gap keeps widening no matter how much the price rises.

The existence of now-chronic temporary backwardation, is proof that gold owners are starting to become reluctant to trust the dollar system, and the lure of profit is insufficient. If they do not trust the delivery of a future, then they have to question if they will be able to buy gold on any terms. In an environment of collapsing credit and bankruptcies, this lack of trust will be quite well founded.

The final stage is brought on by the complete withdrawal of offers to sell gold for dollars (i.e. the gold bid on the dollar). Collapse will come swiftly because of asymmetry. While no gold holder will then want dollars, some dollar holders will desperately want gold. They will buy any goods that have a gold bid. The trade of dollarsàcommoditiesàgold will drive the prices of commodities up to any arbitrary level in dollar terms, and down nearly to zero in gold terms. Oil could become $ 1,000,000 per barrel and 0.0001 gold grams per barrel at the same time. This process will continue until sellers of commodities will no longer accept dollars.

The dollar is fiat, which means imposed by force. It is debt-based, which means its value derives from the efforts of the debtors to continue to pay. And it is irredeemable which means there is no way for debtors, in aggregate, to get out of debt, and no way for creditors to know the terms by which they can get gold. The government uses force to impose the contradiction of a debt-based currency that cannot extinguish debt. People would not accept it otherwise!

The final resolution of such a contradiction is total collapse.

For those interested in tracking the backwardation occurring in both gold and silver right now, Monetary Metals publishes The Last Contango Gold Basis Report (free registration required).

1. http://www.zerohedge.com/news/antal-fekete-responds-ben-bernanke-gold-st…

Zero Hedge

Gold, Redeemability, Bitcoin, and Backwardation

Monday, March 18, 2013

Wednesday, March 13, 2013

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.

Bitcoin Quote

$ 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.

Zero Hedge

Bitcoin Crashed. Again.