What We Learn From This Bitcoin Correction

Swarm Economy: Bitcoin is correcting sharply, as expected. From this episode, we learn (again) that bitcoin is not magic and is not a get-rich-quick scheme, and that the bitcoin financial ecosystem is still terribly insufficient to meet demand.

As I walked off a flight yesterday, the correction was already in progress. Worse, all the trading tools (bitcoinity, bitcoincharts, mtgox) were offline and/or unreachable while the correction kept being in progress. That is not just unacceptable; that is a joke for something that makes the claim to be a billion dollar market.

In my last article about how bitcoin weren’t there yet, I highlighted the dependence on the largest exchange, MtGox, as an example of faults with the ecosystem. This correction certainly highlighted how that was true beyond my suggestions – an exchange that has a ten-minute lag in trading orders at best, and is completely unreachable at worst, can barely be taken seriously as a hobby project – and certainly not as the main hub of a next-generation billion-dollar trading system. MtGox shutting down trading mid-correction was just the icing on the cake that confirmed this.

The crux of it is that MtGox’s dominant status isn’t good for the bitcoin ecosystem, and therefore paradoxically, not for them, either. You’d rather have a 20% market share on a trillion-dollar market than an 80% share on a billion-dollar market. I would argue it’s in MtGox’s interest to foster a competition between itself and other exchanges, in order to grow the overall market. Ideally, we’d see a cross-exchange protocol develop that would make exchanging resilient as well as increase overall trade, like when mobile carriers enabled inter-carrier text messaging and increased traffic dramatically.

We can observe that bitcoin had gone absolutely bonkers in the past month, following an already-strong value appreciation (red trend), roughly doubling every month. In the last sharp correction in 2011, bitcoin quadrupled in two weeks before that correction. Therefore, as bitcoin hit overdrive and went into doubling-every-week mode, as it had done in 2011, I expected a correction was imminent. I had set a sell target a few days out, based on that pattern from 2011, but the correction hit before the sell target. That can obviously happen and is part of the game.

Still, my position in bitcoin is and remains long term (decades).

Recent value trends in bitcoin (chart shows last three months).

This chart shows the past three months of bitcoin, just prior to the correction. Around new year’s, it went from being flat to appreciating slowly but steadily as the FinCEN guideline was published that confirmed bitcoin as a legitimate trading instrument. Then, as Cyprus hit, bitcoin’s value accelerated into Trend 2 on the chart. The past week has gone crazy with media waking up, creating yet another breakout into Trend 3. That trend had the same rate as the rate just before the 2011 correction and trend reversal.

I was worried when the exchange rate seemed to stabilize around $180 right after the correction, as that would mean the correction was only down from Trend 3 and down to Trend 2. That would mean the major correction hadn’t yet arrived and was still to come, at least as I read the chart.

I expect a continued fall of the exchange rate to at least the dominant trend, meaning a value of around $60-$65. [UPDATE: And so it did, right on cue.] Where it goes from there is anyone’s guess. This could be a trend reversal, or it could be a sharp correction with a continued uptrend. (Do note that I’m often wrong, and tend to sell low, buy high, and miss targets when I’m trying to catch short-term swings: see above.)

When I outlined bitcoin’s four hurdles as they looked in 2011, “Exchanges” was one of them. This concern remains, and has intensified as a clear obstacle to bitcoin’s credibility and – perhaps most importantly – trustability.

In the time between the last peak and now, we have gone from GPU mining to ASIC mining (via FPGA mining). ASICs were in the blueprint stage by the last peak, and so, resilience of the network itself has increased a lot. My point is that a lot of seed capital is going into bitcoin companies by now as business angels have fixed their eyes on bitcoin. Hopefully, by the next peak, the initiatives that started this spring will be operational enough to stabilize the ecosystem.

In the meantime, this was not the second peak, but something like the fourth or fifth similar event. We can be certain it is not the last.

Most importantly, failure or success of short-term speculation is irrelevant to bitcoin’s eventual success as a decentralized, resilient currency.

There is no need to repair the exchange rate or think in such terms. The reason I’m mentioning the exchange rate at all in this article is that the bitcoin trading, when it goes intense such as in this correction, puts a merciless spotlight on the inadequacies of the current bitcoin ecosystem.

The good news, as said, is that we may expect a lot of them to be fixed by the next time this happens. Maybe in the spring of 2015, maybe sooner, maybe later.

DISCLOSURE

The author (still) has a significant position in bitcoin.