Bitcoin Money

Bitcoin Ends Month Up 5%, Quarter Up 6%, Year Up 10%

While there was turmoil in most markets around the globe, Bitcoin’s BTC/USD exchange rate just finished its most stable one month period in its history.

For the month of May, 2012 the closing price of $5.197 was nearly a quarter dollar above the previous month’s close giving a 5% gain for the month.  The first quarter had closed at $4.90 so the price is now up 6%, quarter-to-date for 2Q2012.  For the year, which opened at a $4.72 level, the price is now up more than 10%.

Bitcoin is traded much like a currency against the various government currencies that are normally traded on foreign exchange markets.  In addition to having a BTC/USD market at numerous exchanges there are also other currencies that trade against the bitcoin — nearly two dozen in total.  The chart on the right shows that the second largest market is bitcoin versus the British pound sterling (BTC/GBP), and next after that is the Euro (BTC/EUR) followed by an unusual entry (BTC/SLL).  No, the SLL is not the national currency of Sierra Leone which shares the same currency acronym, SLL in this instance refers to Second Life Lindens — another digital currency.

The exchange rate for the other currencies will float but they generally will not vary much from the price at the most liquid market — the BTC/USD market on Mt. Gox.  This is because there is arbitrage between the exchanges occurring and any market inefficiencies are generally resolved as soon as the price delta becomes large enough to make an arbitrage trade attractive.  This assumes, however that traders can move funds to and from the exchanges that operate these various currency markets.

One of the methods for transferring funds between some of the exchanges is Dwolla.  Dwolla was preferred by traders because Dwolla’s account-to-account (A2A) transactions are instant meaning funds received can then be transferred to another destination immediately.  This past month, Dwolla took measures requiring account verification and imposed restrictions on new accounts.  As a result, instead of transfers clearing in under an hour withdrawal requests at Mt. Gox have been piling up and they’re taking a week or more to deliver the funds.  They direct blame for the delays to the changes by Dwolla. This, along with delays in withdrawing international wire transfers at Mt. Gox, have combined to essentially cut the legs out from under the arbitrageurs who were previously becoming quite efficient at being able to keep prices relatively close between most currency market exchanges.

This has caused there to be wider than normal arbitrage opportunities with price differences of a fat juicy 3% or greater just sitting there waiting to be snapped up.  At the same time there is the fear by traders that there are potential security issues remaining at the exchanges and for that reason and others, keeping larger amounts of funds at the exchanges is seen as being risky.  That is an actualized risk that befell those who had funds with Bitcoinica — a financial service that suffered a security breach last month, forcing it to close temporarily.  Several weeks have passsed since the incident occurred and account holders still do not have access to their funds.

This disruption is relevant to keep in mind when looking at the volume of trading occurring.  The leading exchange has seen volume trending down and that continued this month with just $6.3 million worth of trades at Mt. Gox in May.  For comparison purposes, this trading volume level is about a third of the level that occurred in the month of January this year when just under $20 million USD had traded in a single month.  Adding all of Mt. Gox’s various currency markets together gives it a market share of about 62% which means it is still larger than all other Bitcoin exchanges combined but that its trading volume dominance is rapidly shrinking.  Unfortunately this volume decline has only has resulted in larger price deltas between the exchanges rather than the volume (and liquidity) becoming more distributed.

Those holding bitcoins have done so because they:

• Are speculating on its future value (hoarding)
• Have acquired bitcoins for use in future purchases
• Have received bitcoins and haven’t yet cashed them out or spent them

Still to this day speculation is responsible for the vast majority of bitcoins held.  Bitcoin as an investment has been performing better than precious metals and other commodities which  have been hit hard in recent months.

The charts to the right show how much of the asset can be purchased using a single bitcoin over a period of six months. The time span for the charts was cherry-picked using the stating date December 1, 2011 and continues through May 31, 2012.

“How much does a bitcoin buy?” charts:

• Top: Gold  
• Middle: Silver
• Bottom: Crude Oil

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But the use of Bitcoin as a currency has been increasing as well.

A new online gambling service has single-handedly more than doubled the quantity of transactions appearing on the Bitcoin blockchain.

A better view towards determining Bitcoin’s traction would come after excluding the most widely used addresses.  Though the metric still shows activity below the levels from a year ago, they have been climbing steadily throughout 2012.

Miners took in the 220,700 bitcoins that were issued (also referred to as being “mined”) during the month.  Using the average daily valuation of $5.07 the value of these bitcoins issued totals a little over $1.1 million.  Mining profitability hasn’t changed much even with the rising exchange rate as difficulty increased to nearly the same degree.  With the threat from FPGA and ASIC designs, mining operators are less interested in further GPU-based expansion.  Because the backlog for FPGA shipments remains lengthy though the big rises expected for bitcoin difficulty have not yet arrived.

With the (relatively) larger capital requirements to enter FPGA mining, the expansion will likely occur mostly by those mining commercially, many of whom have raised or are raising funds through the GLBSE exchange.  GLBSE is a type of bitcoin-based crowdfunding market that has allowed individuals to “IPO” and raise tens of thousands of dollars worth of bitcoins.  The “investors” however don’t actually have a legal claim to mining profits due to the nature of this cyber-equities market system though.

For every major Bitcoin-related development that occurs, there are many, many others — including launches that might be subtle but have no less the potential to become massively disruptive and successful.

Because Bitcoin is simply an open protocol there are no restrictions on how it is used.  Where there are weaknesses in its ecosystem, there is no executive decision to expend resources to help remedy the situation.  Instead every inch of progress that Bitcoin makes comes from the result of mass collaboration by its participants.  Not only is this causing Bitcoin to move forward, it is causing the pace to accelerate.

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