Don't Blame Deflation for Bitcoin's Volatility

I've recently read a number of articles blaming Bitcoin's notorious volatility on deflation. In reality, deflation in no way implies price volatility.  Consider the Great Deflation. Prices sagged from 1870-1890 due to a slow increase in the supply of money (gold) and a rapid increase in total economic production brought about by the 2nd Industrial Revolution. Prices weren't volatile, they just dropped at a steady rate of about 2% per year.

This may well parallel the situation Bitcoin will face as it matures, as the supply of new Bitcoins slowly increases and the Bitcoin economy grows. Before that can happen, the markets will have to go through a process of discovering things like how widely it will be used for transactions and especially how governments will respond.

The cause of Bitcoin volatility is not deflation, it's caused by speculation under conditions of extreme uncertainty. For better or worse, that uncertainty will eventually be resolved.

One possible indicator that Bitcoin is worth taking seriously is that financial companies have a growing interest in the crypto-currency. While financial laws prevent hedge funds and investment banks from investing in alternative assests like Bitcoin unless they are formed into a licensed financial product. Individuals do not have to abide by these finance regulations.

Even so, Reuters reports that "Workers at Morgan Stanley and Goldman Sachs in London and New York have been visiting online Bitcoin exchanges as often as 30 times a day, according to documents seen by Reuters." So it seems that there is interest, but they are constrained in multiple ways that individuals are not. For example, the total value of all mined Bitcoins is on the order of ~$1 Billion--the entire value of the currency is trivial to large financial companies.

In any case, Bitcoin is a technology worth watching. Expect to see it covered here in the future.

3 Responses so far.

  1. The Men Who Stare At Gox says:

    I have gold, silver, and bitcoin in my portfolio at present. So far, I have managed to double my investment in BTC by selling off less than 20% of my entire bitcoin holdings. I can't tell you where bitcoin is going to eventually end up, but I am already quite pleased with its performance! & thanks for the advice you gave me regarding silver investments btw. Still very solid!

  2. The best way to learn about bitcoin, is to jump in and get a few in your "pocket" to get a feel for how they work Trade bitcoin online

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