Bitcoin's Wild Ride Shows It's Not Real Money

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If you wanted to make the case for Bitcoin as a feasible and useful digital currency, yesterday wasn't the best day to do so. According to Mt. Gox, the largest Bitcoin exchange, the currency started out at $230, spiked to $266, touched a low of $105 and then settled at just above $170 (it's now $123). That's, in the course of the day, a 15 percent jump followed by a 60 percent plunge off the day's high and ending with a substantial loss.

And during the day, it wasn't even clear where bids and offers were, or what the price was at any given moment. Joe Weisenthal of Business Insider reported seeing Bitcoin prices of $90, $170 and $225 on different sites. One exchange appeared to have suffered from a denial of service attack when there were severe lags in trading and quotes. Today, however, Mt. Gox's management team issued a press release saying they were a "victim of our own success" and that a flood of new accounts had overwhelmed the system and led to panic sales by clients that drove down the price. Mt. Gox shut down its exchange today to "allow the market to cooldown" and upgrade its systems.

This level of volatility, along with the difficulty of buying Bitcoins in the first place, and the substantial security risks, is what will stop Bitcoin from being a true alternative to state currencies. For a currency to work, it needs to be a steady store of value. This means that when you buy $10 worth of groceries Monday, that $10 has the same purchasing power for the grocercies on Friday.

When currencies can fluctuate substantially over short periods of time, merchants not only have to continually update their prices, an inconvenience and added cost typically borne by the customer, but they also are forced to become currency speculators, adjusting prices and inventory in accordance to data from a possibly hacked online currency exchange. Merchants who accepted Bitcoin payments yesterday morning were much better off than merchants who sold goods at the same price this afternoon.

Over longer periods of time, widely used and traded currencies like the yen, dollar and euro change in relation to each other, sometimes drastically -- the Yen has depreciated 28 percent against the dollar since October. But there is a deep and liquid market for currency derivatives, such as futures and forward contracts, that help business who buy or sell in different currencies limit their losses (and gains) due to relative price changes. Cheese makers in Northern Italy should focus on cheese, not obsessively tracking the value of the euro in dollars or yen.

No amount of financial engineering can replace low volatility in the value of the currency, which is something that Bitcoin hasn't been able to promise since it started its astounding run up in value in the beginning of March, when it was only at $33. And while a continually rising value brings with it the possibility of hoarding -- as more and more Bitcoin owners are speculators betting on it going up more -- volatility may be an even bigger problem.

In comparison, when the U.S. dollar dropped by around 2 percent on Sept. 23, 2008, shortly after Lehman Brothers went bankrupt, it was seen as a sign that the U.S. economy was entering freefall (it was). Bitcoin would love to see that level of volatility every day; it would be a substantial improvement.

The irony here is that Bitcoin fluctuations are a perfectly free-market phenomenon. There's no central Bitcoin authority introducing new currency, no Bitcoin quantitative easing, no Bitcoin central bank targeting a Bitcoin price. There is none of the "debasement" and "manipulation" that many Bitcoin users claim the Federal Reserve, European Central Bank and Bank of Japan engage in constantly.

Instead, Bitcoin is being treated like a commodity by nervous, paranoid, suspicious speculators looking to make a quick buck. In modern mixed economies, where governments have a heavy hand in overseeing and regulating financial and capital markets, the manias and passions of investors can (sometimes) be tempered and (usually, one hopes) channeled toward productive ends. With Bitcoin, those animal spirits result in wildly gyrating charts and a wildly popular subreddit.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.