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Bitcoin’s Price Swings Threaten Its Chance of Being a Real Currency

Michael Santoli
Daily Ticker

In theory, Bitcoin is many admirable things: a frictionless virtual currency, independent of any state or central bank’s endorsement or printing, useful for storing purchasing power and moving it across borders.

In practice, at least lately, Bitcoin has become a wildly volatile speculative instrument - a collision of hot money, high futuristic hopes for digital money and an illiquid, fractured trading market.

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The price of a Bitcoin in the last 24 hours has surged from $550 -- it briefly spiked to $900 overnight -- before shuttling back below $600 by morning. (It was trading at just $13 in January).

As I discuss with Yahoo Finance Editor-in-Chief Aaron Task in the attached video, such quicksilver price swings threaten to undermine Bitcoin’s utility as a transactional currency. A small but growing group of online and physical merchants accept Bitcoin for goods and services. They need not worry about Bitcoin price swings in real time, as buyer and merchant can each instantly convert a traditional currency to Bitcoin and back without taking much exchange-rate risk. Yet over time a currency that can surge or swoon in value so much in a brief period – unrelated to any underlying economic changes – will likely deter widespread adoption.

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There are enough true believers in the concept and long-term promise of Bitcoin that it is unlikely to fade from the scene any time soon. This is particularly true after the U.S. Justice Department and Federal Reserve officials told Congress yesterday that they believe new electronic payment technologies should prove useful -- statements taken as a tacit acceptance of Bitcoin’s existence, for now.

Because Bitcoin is created in controlled amounts by computer programmers who work through algorithms and process Bitcoin transactions – and only a finite, set amount will ever be “mined” – many believe its main use will be as a store of value. There is no intrinsic value, mind you, but simply a collective evaluation of whether it will be treated as currency over time and whether people will be willing to be paid for their labor in this form.

If one were bullish on Bitcoin’s prospects, then the assumption is the market value of the quasi-currency will far exceed the current $7-8 billion. World physical currency in circulation exceeds $4 trillion, and world annual GDP is more than $70 trillion. Should one believe Bitcoin will gain any significant market share in this mix, the incentive would be to buy and hoard it, expecting it to be exchangeable for money or goods of greater value down the road.

In this way, it can be seen as an idealized, digital form of gold, history’s fallback state-transcendent store of value. Of course, Bitcoin doesn’t have gold’s thousands-of-years track record of acceptance as a form of money, and the Bitcoin arena remains buggy and immature.

Reports have surfaced this week that the shutdown of the drug-and-weapons commerce site Silk Road in early October may have frozen accounts of Bitcoin and taken supply off the market, forcing those who owe Bitcoin to scramble to buy some in the open market. The opening of a Chinese exchange recently has also coincided with the surge in Bitcoin prices, suggesting the outsized influence of newbie hot money.

As a technology and market phenomenon, Bitcoin is fascinating. For most investors, though, it’s probably best to participate only with “play money,” or simply to enjoy the action as spectator.

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