Bitcoin is not just a Volatile Bubble

Robert Wagner, a research analyst at Seeking Alpha, has recently argued that bitcoin is a bubble in the process of popping due to its volatility. However, that may not be the case.

Bitcoin is a Bubble

Bitcoin is not a bubble. Bitcoin is in a price discovery phase at the moment and the outcome of that won’t be known until bitcoin succeeds or fails. Like Tesla, Microsoft, Dell, Facebook, Apple, Amazon, Google, or any other disruptive tech company bitcoin has the potential to rise stratospherically if it achieves its potential. Otherwise like Wesabe, ArsDigita, RiotVine, etc. it will be relegated to the dustbins of history and investors will lose their investment.

Bitcoin is designed with a fixed money supply and therefore is designed to increase in value over time, but that doesn’t make it a bubble; that makes it deflationary.

If bitcoin isn’t a bubble, why does the price rise so fast and then fall so fast? This is because bitcoin is only 5 years old. Just imagine what Facebook’s price chart would have looked like from 2004, when it started in Zuckerberg’s dorm room, through 2009 when it was 5 years old. Facebook's growth from $0 to $6.5 billion represents great volatility as well. Even ten years later and after it’s IPO FB is still quite volatile, and isn’t subject to nearly the same amount of regulatory uncertainty and market uncertainty as bitcoin. It would be crazy if bitcoin’s price were not fluctuating as investors react to positive and negative bitcoin news events.

Bitcoin for Merchants

U.S. merchants can hold bitcoins for a number of good reasons: to pay overseas contractors, to pay employees, to protect funds from asset seizures, or because they can’t have a bank account. However, most U.S. businesses should not hold a large percentage of their assets in bitcoin because of its volatility.

The case for businesses holding bitcoins becomes more interesting thinking globally. Bitcoin offers the least advantage for U.S. businesses because dollars are the reserve currency of the world and it has a strong banking sector. Firms operating in countries with high inflation, like Argentina or Venezuela, should be more receptive to storing assets in bitcoin, which may go up or down, but has always went up year over year, or their government currency which is constantly inflating.

The other mistake many analysts make is assuming businesses have to hold bitcoin to benefit from it. There are payment processors like BitPay and Coinbase that completely eliminate the volatility of bitcoin for merchants, while retaining the benefits of bitcoin such as fraud elimination and the elimination of chargeback risk.

Volatility

Bitcoin is not designed to be volatile. Quite the opposite, bitcoin is designed to be stable. Why isn’t it stable today? It is a 5 year old technology being compared to gold, which has a 5000 year history and the U.S. dollar. Why does the price of gold fluctuate? If gold were the unit of account for U.S. transactions, meaning everything is priced in gold, prices would likely not increase over time like they do being priced in U.S. dollars. The prices would probably decrease as companies use technology to more cheaply deliver goods and services. This means that the USD is designed with volatility, also known as inflation, and not the other way around.

Bitcoin is designed to be stable because it has a finite money supply and a predictable rate of money injection. These two features mean investors and bitcoin users know what the bitcoin money supply will be at any point in time. That is not true for any other well known asset. The only thing investors don’t know is the future demand for bitcoins, but that is true for all assets.

Bitcoin’s price volatility will be eliminated once it is used as the unit of account for goods and services instead of USD. Once a supply chain is denominated top to bottom in bitcoin the prices in that chain will no longer be subject to inflationary pressures that increase volatility.

Summary

Digital money is here to stay. Wagner believes it is a bubble destined to pop because of its volatility. At this point in time bitcoin is most likely to be the digital money of the future. The rapid downfall of AOL, Netscape, and MySpace shows us technology trailblazers can quickly die. However, it does not seem that the current price discovery process causing bitcoin's volatility will kill bitcoin.