Price plummets and deep pools

Wednesday 12 February 2014

Bitcoin volatility

Bitcoin prices have seen a lot of volatility in recent days, but why has this happened and importantly, how resilient is bitcoin to future setbacks?

Between Feb 5 and 8, Bitcoin prices plummeted mainly due to the following news:

  • Apple removing the app from the Apple store
  • A supposed ban by the Russian government and its central bank
  • The freezing of bitcoin redemptions from Mt Gox

Apple removing app

The removal of the app was negative news but not entirely unexpected due to Apple's unofficial stance on applications that transacted in bitcoins. There was some consternation felt because the smart mobile phone market in the US is currently dominated by Apple.

However, in the longer run, Apple's conduct could most likely hurt Apple rather than bitcoin because it demonstrates the somewhat arbitrary nature of Apple's decisions to include or remove apps from their store. Further, bitcoin adoption is rising and those new users will probably choose to use phones from the Android ecosystem, where app inclusions are not so opaque and arbitrary.

Russian ban

The ban in Russia was largely seen as the re-emphasis of existing laws in Russia preventing the use of any currency other than the Russian Ruble.

The immediate impact has been the suspension of direct ruble to bitcoin conversion on one of the major exchanges, To obtain bitcoins, Russians must now switch from rubles to dollars or euros before converting to bitcoins.

Bitcoin exchanges have now been driven underground in Russia. We’ll see this situation evolve further with interest over the days and weeks ahead, to see what Russian bitcoiners develop to overcome these hurdles.

Mt. Gox

Many of you already know Mt. Gox; it is the world’s first Bitcoin exchange and is based in Japan.

Over the past few months, Mt. Gox has been losing marketshare to other bitcoin exchanges due to internal technological issues at Mt Gox. Bitcoin prices on Mt. Gox were higher than at the other exchanges for months, as people couldn't withdraw cash from Mt Gox and so purchased bitcoins on the exchange to withdraw bitcoins instead.

Recently, bitcoin prices on Mt. Gox dropped lower than the other exchanges, very suddenly, because bitcoin withdrawals at Mt Gox also began to experience withdrawal issues. People sold their bitcoins on Mt. Gox because they feared that Mt Gox didn’t have enough bitcoins to pay everyone out.

Finally, last week, Mt. Gox suspended bitcoin withdrawals altogether. Panic spread as people tried to withdraw bitcoins but couldn’t.

Mt. Gox has made a public statement that they are experiencing technical faults and that services will be resumed after they have resolved the problem. Presumably, Mt. Gox has sufficient bitcoins in reserves to ensure everyone is paid out.

It appears that Mt. Gox's active holdings of bitcoins may have been depleted by attackers who managed to withdraw multiple amounts from Mt. Gox due to the way Mt Gox confirms successful transactions. However, it appears that Mt. Gox's cold storage reserves of bitcoins are unaffected, which means that this will probably be a painful and expensive lesson for Mt. Gox but that it should probably survive.

Bitcoin volatility

It is interesting to note that as a result of the above events, approximately 100,000 bitcoins were transacted between February 6 and 8 on the largest exchange, Bitstamp. In US dollar terms, a staggering US $70 million in bitcoin transactions occurred over three short days on that one exchange alone.

As a consequence, bitcoin’s value dropped from US $800 to a low of US $604, before rising to around US $700 per bitcoin, as of the time of writing.

In a similar episode from December 16 to 18, when China banned payment processors from interacting with Bitcoin exchanges, about 200,000 coins changed hands on Bitstamp, causing bitcoin’s price to hit a low of US $382 per bitcoin.

Is Bitcoin stabilising?

Are we seeing bitcoin mature as a currency or is it because the twin impact of the Russian ban and Mt Gox panic was not as large as China’s payment processor ban in December 2013?

I think what we can say is that bitcoin prices are quite resilient even though tens of millions of dollars’ worth of bitcoins were dumped on global exchanges.

For comparison, the transaction volume of Apple shares fluctuates between US $15 to $25 million per day (according to Wikinvest). If what happened to Bitcoin happened to Apple shares, 0.8% of the total amount of Apple shares would have been sold over three days, which is equivalent to dumping US $3.6 Billion worth of Apple shares.

So why are bitcoin prices holding up relatively well? I think there are a few factors to consider:

  • Bitcoin, as a technological advancement, is still viewed as undervalued and investors are willing to buy bitcoins when the price plummets.
  • There appears to be a significant amount of speculative money waiting on the sidelines for moments when bitcoin prices fall. i.e. Bitcoin investors appear to have adjusted their risk expectations in keeping with the volatile environment.
  • Lastly, it might simply be that many of the investors who sold bitcoins returned to buy them again once the price had fallen sufficiently in each individuals' eyes. i.e. The net exit of dollars from Bitcoin exchanges was much less than US $70 Million.

So even though the price volatility of Bitcoin is uncomfortable, one can be quite amazed that there was US $70 million available to purchase the 100,000 bitcoins that were sold over three days on one exchange alone.

Bitcoin is slowly becoming a deeper and liquid market for global trade. It's still very early days in terms of development, and I think we can expect these pools of liquidity to deepen considerably over the months and years ahead.

By Lloyd Chin


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