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Bitcoin’s Recent Volatility Risks Deflationary Spiral, Could Undermine It as a Currency

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Bitcoin’s price has been rising for the past two months and skyrocketing for the past few weeks. As of this writing, prices are fluctuating wildly across multiple exchanges, with some listing a per-BTC price as high as $ 18,259 and others holding around the $ 16,500 mark. It’s unusual to see gaps that large between exchanges, and the cryptocurrency’s price-per-BTC has exploded in the last year — but especially in the past few weeks. The graph below shows how BTC’s value has changed from January 1 2017 to December 7.

BTC-Chart-2017

Whatever the number underneath that line graph says, it’s definitely different now.

Two days ago, Valve announced that it would no longer accept Bitcoin as a currency for its games on Steam. We dug into that situation yesterday, but we’ll summarize again here: Large fluctuations in Bitcoin’s price, its transaction fees, and in the time required to complete transactions has left Valve unable to guarantee that the price people are asked to pay when they attempt to do so will reflect the cost and transaction fees by the time it’s processed. While Valve is just one company, and the success or failure of BTC or other cryptocurrencies won’t be determined by whether you can use them to buy games on Steam, the company’s decision to withdraw from the market is indicative of the larger problems surrounding any attempt to use BTC as a currency under conditions like these.

A little over three years ago, I teamed up with Dr. Justin Gash, Professor of Mathematics at Franklin College, to chart how Bitcoin prices had changed up to that point and what to expect in the future. At the time, we predicted Bitcoin would tend to deflate (meaning the value of one BTC would tend to increase over time), though we also noted that other factors, like changes to how BTC was regulated by various countries or adopted as accepted tender by businesses, would also impact this trend. Time has proven this accurate, but this rapid expansion over the past month is not good for the currency (assuming you intend to use it as currency). On the other hand, it’s been fabulous for people who held BTC or mined it over long periods of time. The chart above shows BTC prices going back to the beginning of 2017; the chart below shows BTC prices back to the beginning of the currency. The September 8th, 2014 date and price are called out because our article ran that week.

BTC-Chart2

Two different charts, grabbed only about 40 minutes apart, and the valuation has dipped significantly.

Bitcoin’s enormous rally in the past few months is out of all proportion to any previous gain, including its increase throughout 2016. The higher the rate of deflation, the faster a currency appreciates in value. At first glance, this sounds thoroughly agreeable: Which of us wouldn’t like knowing that come December 7, 2018, the dollars in our bank accounts would be worth 5x more than what they are today? You could buy a $ 1,500 gaming laptop for $ 300. A $ 2,000 18-core Intel Core i9-7980XE would cost you just $ 400, and a 16-core Threadripper would cost you less than an AMD Ryzen 5 1600 does today.

But this kind of rapid, intense deflation causes severe problems in economies. If you know that a dollar today is worth $ 5 a year from now, you’re going to fight like hell to avoid spending a single dollar more than you absolutely have to. In fact, you may choose to temporarily go without things you’d otherwise purchase. One of the problems with a widely fluctuating price for goods and services that’s also in a deflationary spiral is that even fractional amounts of money at the time you spend them are later worth insane amounts of capital. The first Bitcoin transaction for a real-world set of goods and services was when Laszlo Hanyecz paid 10,000 BTC for two pizzas. That came to to $ 41 at the time — and would now be $ 150M to $ 160M today. Anybody hungry enough for pizza in 2010 that they couldn’t have skipped it for that kind of return seven years later?

Bitcoin isn’t a conventional currency, and so we can’t critique it from exactly the same perspective. But rapid deflation is still a huge problem for any effort to convince consumers or companies to adopt or accept it as tender. If consumers expect Bitcoin (or any cryptocurrency) to rapidly appreciate in value, they’re not going to spend it. If companies believe that cryptocurrency valuations are going to rapidly rise or fall, they’re going to be less likely to use it. If a cup of coffee costs (hypothetical numbers only) 1 BTC at 7 AM, and 0.0000000001 BTC at 5 PM, every Starbucks owner with at least one BTC-using early commuter in their area will forever wax rhapsodical about the time they sold — and retired — on the profit margin earned on a single cup of coffee.

Combine high volatility with widespread use, and companies would have to curtail the amount of BTC they accepted as tender to avoid exposing themselves to ruinous financial risk. Larger companies, that tend to run on Net 30 or Net 60 payment dates, would be even more at-risk. We’ve talked about this problem when using browser mining to raise money for websites; the more volatile the currency, the greater the risk.

One of the stronger arguments for why BTC shouldn’t be considered a cryptocurrency is anchored in the behavior of its holders. As The Atlanticdiscusses, Bitcoin owners don’t typically spend it at all. As they write:

If the predominant use case for any asset is to buy it, wait for it to appreciate, and then to exchange it for dollars, it is a terrible currency. That is how people treat baseball cards or stamps, not money. For most of its owners, bitcoin is not a currency. It is a collectible—a digital baseball card, without the faces or stats.

There are useful roles that Bitcoin can play in the larger cryptocurrency market without being considered a cash-equivalent currency for buying things. There are undoubtedly many people who consider its collectible aspect to be a feature, not a bug. The degree to which BTC can continue to straddle both spaces is very much open to debate.

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