During the recent exponential rise in the price of Bitcoin, there were jokes all over the Internet about the fall of the dollar—more than 80% in Bitcoin terms. Why not measure the value of the dollar in terms of tulips? One must measure the more variable unit with the more constant. Dollars are used to measure Bitcoin, not the other way around (and one must measure the value of the dollar using gold).
As we can see in the table below (taken after the crash on Wednesday) the stack of bids and offers was quite thin. If one needed to sell $10,000 worth of Bitcoins one would push the bid down to $29. Copper, even late at night, has vastly more liquidity than this. Bitcoin might be more similar to options on May 2017 molybdenum futures.
Regardless of whether or not Bitcoin is a “good”, the bid-ask spread is the opposite of what we would expect to see for something that is claimed to be money. Money is the most marketable good. The key attribute of marketability is a narrow bid-ask spread that does not widen much as the quantity increases. Needless to say $10,000 is not a large quantity. It’s just a handful of gold coins. Bitcoin is not very marketable (I also argue that it is not a good).
A wide bid-ask spread, with a thin stack of bids and asks, is conducive to spikes and crashed. The moment someone enters the market who must trade immediately (and hence must take the bid if he is a seller or the ask if he is a buyer), he will move the market disproportionally. This creates a feedback loop for a while as the market makers pull back, concerned with the volatility. If another seller jumps, the market could collapse.
Bitcoin also has another problem. It can be disrupted by denial-of-service attacks. A DOS attack may have begun the cascade of events that turned into the crash through the stack of bids from $265 down to $108.
The time may not be right yet, but we would love to see a similar technology to provide a gold-redeemable cryptographic based currency. “BitGold” would not be based on the labor theory of value (i.e. “mining” to generate new coins), the quantity theory of money (i.e. absolute cap on the quantity of coins). It would not be plagued by a ridiculous bid-ask spread. In short, it would behave as dollar bills did before the advent of the Fed. Arbitrage would set the value of BitGold. There could be competing BitGold systems. With Bitcoin, the system depends on the network effect. Multiple competing crypto-currencies would dimish the value of one another (not to mention blow away the whole idea of the cap on the number of currency units in circulation).
Anyone interested in this should contact us. We have some ideas and may be able to help.