Bitcoin Air-Kisses the Euro

bitcoin, euro, volatility,

Volatility is a well-recognized impediment to the success of Bitcoin as a currency.  An example of the argument for volatility-based caution about Bitcoin, chosen at random, appears in Professor David Yermack’s December 2013 NBER working paper, “Is Bitcoin a Real Currency? An Economic Appraisal.”  Wide swings in the price of bitcoins vis á vis other things will obviously tend to suppress its utility as a store of value or unit of account.  Nobody wants to deal with recalculating prices denominated in Bitcoin day over day or hour over hour.

But I’ve long felt the volatility knock on Bitcoin to be slightly unfair.  My favorite response line has been to say that judging Bitcoin based on its current volatility is like declaring a 10-year-old unfit to play in the NBA because he’s too short.

As a new asset class (or very different member of the “cash or cash equivalent” asset class), Bitcoin has yet to find its place in the world.  The uses to which it is put will ultimately translate into a dollar price based on a recognized, relatively steady level of demand.  Right now, speculation about where demand for Bitcoin will end up takes place in thinly traded markets.  Just those two ingredients — uncertain future use and thin markets — are recipe enough for plentiful volatility.

But there’s every reason to believe that the market for Bitcoin will deepen and grow in sophistication, tempering its volatility.  The capacity of the Bitcoin protocol to transfer and store value in exciting new ways will produce transaction demand — supplanting speculative demand, which today dominates because of anticipated price appreciation.  Transaction or “use” demand will also increase because of Bitcoin’s capacity to administer countless economic and social functions beyond value transfer, including messaging, proof of authorship, land and title registry, and identity/naming.  This will drive volatility down, I believe, both because it will shift bitcoins out of speculation and because it will give the markets more concrete information about what use demand is and will be.

Based on an estimate from two years ago or so — eons in Bitcoin time — I spent much of 2014 saying that Bitcoin volatility was dropping at a rate of about two or three percent per year.  This suggested that it would have dollar-price stability similar to that of the Euro in ten to fifteen years.  That’s not bad for an all-new currency (or whatever Bitcoin is).  It’s looking, though, like that time estimate was wrong.

Eli Dourado at the Mercatus Center recently updated his site for tracking Bitcoin volatility to include some other currencies and assets.  The update opens new and interesting windows.  In particular, it reveals that earlier this year, the Euro and Bitcoin had nearly the same 30-day volatility against the dollar.  On June 8th, Bitcoin had volatility of 1.13% and the Euro’s was 1.00%.

bitcoin, euro, volatility,

That doesn’t suggest at all that Bitcoin’s volatility problem is solved.  When the two volatilities air-kissed, Bitcoin’s was near a historic low and the Euro’s was at a high.  Bitcoin’s volatility has risen again since, with jumpy Bitcoin prices attributable to the summer’s machinations in Greece and Bitcoin’s “blocksize” debate.  But the overall trend shows a marked and relatively rapid drop in volatility relative to my earlier prediction of ten- to fifteen-year parity.

bitcoin, volatility, trendline

Using Dourado’s data, it’s easy to make a graph that, while far less attractive, shows the strong downward slope to Bitcoin’s volatility.  That trend won’t continue, and it will still be some while before Bitcoin has the kind of low volatility that makes it a reasonable store of value or unit of account for people whose alternatives are the dollar, the Euro, and other major currencies.  But many people around the world are not in that category.  They may adopt Bitcoin to protect themselves from local currencies with even greater swings, or consistent loss of value.  This will improve the volatility picture for the rest of us.

I see many virtuous dynamics around Bitcoin volatility in the offing.  These may be relevant, or they may be evidence of my need for education.  Eli takes pains to point out on his site that the Bitcoin and Euro volatility numbers are incompatible because markets for fiat currency are closed on weekends and holidays.  The data “are presented for entertainment purposes only,” he says.  I agree with the sentiment, and offer this post in the same spirit.

  • John Hall

    It seems fishy to me to regress a trend line on volatility. Maybe if you fit a garch model with a time trend, then that would be a bit more convincing. I'm not saying there isn't a trend or that it isn't statistically significant. I just wouldn't be surprised if the trend was not as strong.

    • Andrew_FL

      From a pure statistical modeling point of view, a linear trend line shouldn't be fit to any variable which cannot go below zero. So it's not the best choice, no.

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  • Right now, no one is lending bitcoin so it can’t expand credit, but neither can it solve the problem of credit expansion. But suppose that someone sets up a bank that will lend in bitcoins. Does anyone suppose that such a bank will abstain from fractional reserve banking? Not likely! The process is too lucrative. It’s virtually legal counterfeiting. And once banks are lending bitcoins and keeping fractional reserves, bitcoin will be a part of the problem.

    • Shawn

      There is nothing innately wrong with fractional reserve banking. Albeit in the current system it is not always beneficial.

      • True, but it does cause the business cycle according to the Austrian theory.

        • Andrew_FL

          According to Rothbard's interpretation, maybe. The question is whether, as Rothbard believed, the creation of additional money and money substitutes even in response to an increase in the demand to hold real money balances necessarily lowers the market rate of interest below that consistent with the equating voluntary savings to investment, or whether this only occurs if increases are not in response to increased demand to hold real money balances.

          Many early Austrian writers did not really offer a clear answer on this question-Mises sometimes seems like he believes the former, sometimes the latter. Hayek's MV norm seems to imply a view more like the latter but Hayek was also very skeptical of free banking. Rothbard took the question head on, probably the first Austrian writer whose position on this issue was completely unambiguous. Most Austrian writers have followed Rothbard on this issue since, but not all of them.

          Personally I found Selgin's The Theory of Free Banking very helpful on this, especially the distinction between Transfer Credit and Created Credit. It is the latter, not the former, which sets in motion the unsustainable boom.

          • Agreed, but people will demand larger cash balances only in a recession. It’s not a random event or a “shock” as mainstream econ assumes. Hayek approved of expanding the money supply to meet that demand and reduce the chances of a secondary recession. Such lending will not cause price inflation because consumers will hang on to the new money, but it will launch the artificial boom in investment in capital goods that initiates the business cycle.

            BTW, Hayek did support free banking. In “Monetary Nationalism” he includes free banking with an international currency as the only two solutions to the problem of currency instability, but dismisses both as politically impossible. Then in chapter 18 of “Law, Legislation and Liberty”

            Hayek wrote, “Since I am convinced that there are now no longer any rigid rules possible which would secure a supply of money by government by which at the same time the legitimate demands for money are satisfied and the value of that money kept stable, there appears to me to exist no other way of achieving this than to replace the present national moneys by competing different moneys offered by private enterprise, from which the public would be free to choose which serves best for their transactions.”

          • Andrew_FL

            I don't think "only" in a recession is correct, and making categorical statements about the content of peoples preferences doesn't seem very Austrian to me?

            But, supposing it is true, if only by definition, let's move on to the second issue: Hayek was indeed skeptical of free banking:


            Hayek's later view, in support of competing private fiat moneys, is something different in very important ways from free banking as Mises (who, despite having er, reservations, about fraction reserves, unequivocally supported free banking) and anyone else would have understood it before Hayek came up with his idea. And actually, Hayek's later view, that competing private issuers of fiat outside moneys would stabilize the price level, was a theoretical retrogression from Prices and Production, in so far as he implied a stable price level would be desirable.

            Don't get me wrong, Hayek's contribution was crucial to the revival of the idea of free banking, but it wasn't free banking per se.

          • Mises and Hayek discuss peoples’ preferences when writing about money. They describe why people prefer to hold cash in the first place, what benefit they perceive from holding cash, why they won’t in equilibrium. I think if you read the first chapters on epistemology of Human Action you’ll find that understanding how people think is at the heart of Austrian econ.

            In addition Lachmann had this to say in "Capital and its Structure":

            "'Asset preference' is not an ultimate determinant in the sense in which a taste for tobacco is. We have to ask why at certain times certain people prefer one kind of asset to another. It follows that a theory of assets cannot be framed on the static model of the General Theory of Consumption. The composition of asset holdings and its changes make sense only as a response to change, expected and unexpected. By the same token the distribution of money holdings cannot adequately be explained by 'liquidity preference'." 89

            People will generally hold larger cash balances if their income increases, but that won’t cause any disturbances because it’s income driven and they don’t have to cut back on spending. The only time the desire for greater cash balances causes a problem is when the cash isn’t there so they must cut back on spending and investing.

            Well, I read Hayek’s call for private banking as the same thing as free banking. I can’t see how they differ.

          • Andrew_FL

            Roger-I don't think I was clear what I meant about categorical statements about people's preferences. I read Austrians as focusing on the implications of human preferences, rather than the content. I think that's only proper. People may from time to time prefer to accumulate larger cash balances for any number of reasons. Recessions are definitely one reason. I don't think I understand why that should be the only reason. For the record, I wasn't thinking of liquidity preference as a reason.

            "People will generally hold larger cash balances if their income
            increases, but that won’t cause any disturbances because it’s income
            driven and they don’t have to cut back on spending. The only time the
            desire for greater cash balances causes a problem is when the cash isn’t
            there so they must cut back on spending and investing."

            This problem only comes about because of regulation of banking. If banks issued their own notes as paper claims to some commodity then people could accumulate those notes to satisfy their increased demand for real cash balances, and banks would interpret this, correctly, as an increased supply of savings which would lead to more investment, not less.

            The difference between Hayek's idea and free banking is probably best thought of this way: free banks issue inside money, (technically, a money substitute) paper claims to basic money. Hayek's banks are more like so many gold miners supplying outside money, but with a near zero cost of production. Under the gold standard, it was the fact that gold mining was costly which stabilized the price level over time. Hayek proposes that competitive forces will stabilize the price level of private fiat moneys over time, which is an interesting thought but even if true, is not actually desirable according to Hayek himself in Prices and Production. So there's a substantive difference between how private fiat money issuers would work according to Hayek, and how free banking would work.

            And for the record I have read the epistemology parts of Human Action. Their reputation is well deserved. I rarely if ever got the impression Mises was over generalizing about the typical content of people's preferences.

            I don't want to give you the impression I'm trying to get into an argument here. I actually quite enjoy your blog. I especially enjoyed your post on EMH, and also the idea you expressed in the comments.

          • George Selgin

            Hayek's proposals and free banking are quite different things, as I explain here:

    • M. Camp

      Spot on. Counterfeiting is lucrative if its declared legal for a small enough class, and if they exercise enough mutual constraint to keep the racket going. Counterfeiting of national currencies existed to a limited extent in Roman times, but didn't become common until the Middle Ages when it was made legal for bankers (not for others, though).

      If counterfeiting of bitcoin were made legal then you are right that the incentives would be such as to make it common, and bitcoin would become as you said part of the problem of fractional reserve banking–generally destructive booms and busts that are lucrative only to a select few.

      If counterfeiting of bitcoin isn't made legal then this won't happen.

  • Bitcoin = Chuck E Cheese Tokens

    Bitcoin is not a legitimate alternative to a free market banking system nor is it a currency. If it is anything it is a commodity, of air I presume. It is modeled after the mining industry. So people are mining a commodity, with a supposedly limited supply.

    Instead of computer programmers and mathmeticians "mining" bitcoin why don't we have kids "mine" tokens at Chuck E Chees by playing Wak a Mole? All we would have to do is go ahead and let the kids walk out of the place with them. It would not even need to be physical. Chuck E Cheese could simply post the tokens to an online account and people could save them, merchants could accept them and just like Bitcoin a market would develop where the tokens could be exchanged for dollars at a price to be determined by buyer and seller.

    And why stop there? Why should programmers, mathmeticians and children have all the "money". How about I set up a basketball court and I will hand out BBCoins for 3-pt shots made? Same thing as BC and CECC just set up a "blockchain" and presto! And, don't tell me about how Bitcoin has a limited supply. To get the same result I get get the moles to pop up and down faster and faster and/or blindfold the kids. The 3-pt line? I would just keep moving it back.

    Bitcoin is sheer and utter nonsense, not to mention it has no business being a currency. And commodities should not be money either, they should be commodities. Free market credit based banking and note and depoit issue is the answer.

    • M. Camp

      Why do you say Bitcoin isn't a currency?

      • Bitcoin is a commodity not a currency. If i ran around with a debit card for an account that held a barrel of oil I "mined" and when i made a purchase my oil account decreased (was sold for dollars) and the liquidated portion was paid to a merchant who now held dollars the debit card nor the oil is a currency, the dollar is.

        • M. Camp

          In your example, does the account hold dollars or a barrel of oil? The example is confusing because at first you said it held a barrel of oil, and when you made a purchase your oil account decreased. But then you said the merchant didn't receive oil, but rather dollars.

    • M. Camp

      |why don't we have kids "mine" tokens at Chuck E Chees by playing Wak a Mole?

      Because it wouldn't be fair to let children create money for themselves, and because it wouldn't work, since there is no system of incentives to make it stable.

      New bitcoin money should continue to go, as it always has, to the seller of the goods in the transaction. He deserves it because, and only because, the buyer (the previous owner of the money) has voluntarily agreed to the transfer of his rightful property. The only thing the creator of bitcoin deserves is the small-to-non-existent transaction fee that was voluntarily offered by the previous owner of the money, and accepted by the miner. The fact that the buyer freely offered to pay the miner for the transaction service is the reason, and the only reason that the miner deserves his small fee.

      • I respectfully disagree with your assessment. Some more thoughts on the subject matter:

        • M. Camp

          Thanks, read your webpage. Yes, we disagree. I would like to know exactly where.

          Let's take a hypothetical example. We will start with the simplest case of a transaction where no money (or bitcoin, if you feel that bitcoin shouldn't be counted as money) is created and if we have no disagreement there, we shall add the case where money is created.

          You have exactly x bitcoin, and decide to by a hamburger. You and the vendor agree to payment of x bitcoin. You enter "zero bitcoin" as the fee offered for validating the transaction. Some generous person accepts. He buys 5 cents of electricity from his utility company to run the validation app, and validates it.


          a. Slightly less than 3 cents worth of gravitational potential energy in an Oregon reservoir, 1 cent in nuclear potential energy, and 1 cent in fossil fuels chemical potential energy have been turned into electricity and then into atmospheric heat by the minter's computer.

          b. everyone in the world has accepted the updated ledger except the N. Korean government. They try for a few hours to promote a false ledger but they don't have enough compute power to match that of all the honest people in the world, nor enough electricity, and with every passing minute the cost of substituting a false ledger increases astronomically. They finally give up. Now the whole world has accepted the honest ledger.

          c. the vendor has x bitcoin and one less hamburger

          d. you have no bitcoin, and a hamburger

          e. the nice person has 5 cents less, plus the satisfaction of doing a good deed, net gain to him of 1/10 of one cent.

          f. the stockholders of the utility company have 1/20 of the 5 cents more (5 cents from the nice person, less their increased costs of 95% of that). The stockholders of the coal company have some of that, and so on and on. The greenhouse effect increases the global temperature by an unknown amount.

          Let's assume that all the sub-transactions were voluntary except the externalized ones. (Global temperature increase, eg). What about this transaction do you object to, if anything? There are many transactions I've left out; if any are material to your argument, add them in please.

          (I myself object to some things about it but you go first.)