Bitcoin is Not Too Volatile
Has anyone you respect ever told you that bitcoin doesn’t make any sense? Maybe you’ve seen the price of bitcoin rise exponentially and then seen it crash. You write it off, believe your friend was right, don’t hear about it for a while and think bitcoin must have died. But then you wake up a few years later, bitcoin hasn’t died and somehow its value is a lot higher again. And you start thinking maybe your skeptical friend wasn’t right?
The list of bitcoin skeptics is long and distinguished (see here), but the noise contributes directly to the antifragile nature of bitcoin. People that store wealth in bitcoin are forced to think through first principles in order to understand characteristics of bitcoin which otherwise seem, on the surface, to contradict an establishment view of money, which ultimately hardens convictions. Bitcoin volatility is one of these oft-criticized characteristics. A common refrain among skeptics, including central bankers, is that bitcoin is too volatile to be a store of value, medium of exchange or unit of account. Given its volatility, why would anyone hold bitcoin as a savings mechanism? And, how could bitcoin be effective as a transactional currency for payments if its value could reasonably drop tomorrow?
The principal use case for bitcoin today is not as a payments rail but instead as a store of value, and the time horizon for those that store wealth in bitcoin is not a day, week, quarter or even a year. Bitcoin is a long-term savings mechanism and stability in the value of bitcoin will only be realized over time as mass adoption occurs. In the interim, volatility is the natural function of price discovery as bitcoin advances down the path of its monetization event and toward full adoption. Separately, bitcoin does not exist in a vacuum; most individuals or businesses are not singularly exposed to bitcoin and exposure to multiple assets, like any portfolio, mutes volatility of any single asset.
Not Volatile ≠ Store of Value
It is fair to say that volatility and store of value are often confused as mutually exclusive. However, they most certainly are not. If an asset is volatile, it does not mean that asset will be an ineffective store of value The opposite is also true; if an asset is not volatile, it will not necessarily be an effective store of value. The dollar is a prime example: not volatile (today at least), bad store of value.
Volatile things are not necessarily risky, and the reverse is also true.
The Fed has been highly effective in very slowly devaluing the dollar, but always remember, gradually, then suddenly. And, not volatile ≠ store of value This is a critical mental block that many people experience when thinking about bitcoin as a currency, and it is largely a function of time horizon. While central bankers all over the world point to bitcoin as a poor store of value and not functional as a currency because of volatility, they think in days, weeks, months and quarters while the rest of us plan for the long-term: years, decades and generations.
Despite the logical explanations, volatility is one area that particularly confounds the experts. Bank of England Governor, Mark Carney recently commented that bitcoin “has pretty much failed thus far on […] the traditional aspects of money. It is not a store of value because it is all over the map. Nobody uses it as a medium of exchange,” (see here)The European Central Bank (ECB) has also mused on Twitter that bitcoin is “not a currency”, noting that it is “very volatile” while at the same time reassuring everyone that it can “create” money to buy assets, the very function by which its currency actually loses value and why it’s a poor store of value.
The lack of self-awareness is not lost on anyone here but Mark Carney and the ECB are not alone. From former Fed Chairs, Bernanke and Yellen, to current Treasury Secretary Mnuchin to the President himself. All have, at times, trumpeted the idea that bitcoin is flawed as a currency (or as a store of value) because of its volatility. None seem to fully appreciate, or at least admit, that bitcoin is a direct response to the systemic problem of governments creating money via central banks or that bitcoin volatility is a necessary and healthy function of price discovery.
But luckily for all of us, bitcoin is not too volatile to be a currency and often the experts are not experts at all. Setting logic aside, the empirical evidence shows that bitcoin has proven to be an exceptional store of value over any extended time horizon despite its volatility. So how could an asset such as bitcoin be both highly volatile and an effective store of value?
Bitcoin Value Function Revisited
Consider why there is fundamental demand for bitcoin and why bitcoin is naturally volatile. Bitcoin is valuable because it has a fixed supply and it is also volatile for the same reason. The fundamental demand driver for bitcoin is in its scarcity. To revisit bitcoin’s value function from a previous edition, decentralization and censorship-resistance reinforce the credibility of bitcoin’s scarcity (and fixed supply schedule) which is the basis of bitcoin’s store of value property:
While demand is increasing by orders of magnitude, there is no supply response because bitcoin’s supply schedule is fixed. The disparity in the rate of increase in demand (variable) vs. supply (fixed) combined with imperfect knowledge amongst market participants causes volatility as a function of price discovery. As Nassim Taleb writes in The Black Swan of Cairo: “Variation is information. When there is no variation, there is no information.” As bitcoin’s value increases, it communicates information despite the volatility; the variation is the information. Higher value (dependent on variation) causes bitcoin to become relevant to new pools of capital and new entrants which then stokes an adoption wave.
Adoption Waves & Volatility
Knowledge distribution and infrastructure fuel adoption waves and vice versa. It is a virtuous feedback loop and a function of both time and value. As value rises, bitcoin captures the attention and mindshare of a much wider audience of potential adopters, which then begin to learn about the fundamentals of bitcoin. Similarly, an appreciating asset base attracts additional capital not only as a store of wealth but also to build incremental infrastructure (e.g. more on-ramps & off-ramps, custody solutions, payments layers, hardware, mining, etc.). Developing an understanding of bitcoin is a slow process, as is building infrastructure, but both fuel adoption which then further distributes knowledge and justifies additional infrastructure.
Knowledge → Infrastructure → Adoption → Value → Knowledge → Infrastructure
Today, bitcoin is still nascent and current adoption likely represents \
Has anyone you respect ever told you that bitcoin doesn’t make any sense? Maybe you’ve seen the price of bitcoin rise exponentially and then seen it crash. You write it off, believe your friend was right, don’t hear about it for a while and think bitcoin must have died. But then you wake up a few years later, bitcoin hasn’t died and somehow its value is a lot higher again. And you start thinking maybe your skeptical friend wasn’t right?
The list of bitcoin skeptics is long and distinguished (see here), but the noise contributes directly to the antifragile nature of bitcoin. People that store wealth in bitcoin are forced to think through first principles in order to understand characteristics of bitcoin which otherwise seem, on the surface, to contradict an establishment view of money, which ultimately hardens convictions. Bitcoin volatility is one of these oft-criticized characteristics. A common refrain among skeptics, including central bankers, is that bitcoin is too volatile to be a store of value, medium of exchange or unit of account. Given its volatility, why would anyone hold bitcoin as a savings mechanism? And, how could bitcoin be effective as a transactional currency for payments if its value could reasonably drop tomorrow?
The principal use case for bitcoin today is not as a payments rail but instead as a store of value, and the time horizon for those that store wealth in bitcoin is not a day, week, quarter or even a year. Bitcoin is a long-term savings mechanism and stability in the value of bitcoin will only be realized over time as mass adoption occurs. In the interim, volatility is the natural function of price discovery as bitcoin advances down the path of its monetization event and toward full adoption. Separately, bitcoin does not exist in a vacuum; most individuals or businesses are not singularly exposed to bitcoin and exposure to multiple assets, like any portfolio, mutes volatility of any single asset.
Not Volatile ≠ Store of Value
It is fair to say that volatility and store of value are often confused as mutually exclusive. However, they most certainly are not. If an asset is volatile, it does not mean that asset will be an ineffective store of value The opposite is also true; if an asset is not volatile, it will not necessarily be an effective store of value. The dollar is a prime example: not volatile (today at least), bad store of value.
Volatile things are not necessarily risky, and the reverse is also true.
The Fed has been highly effective in very slowly devaluing the dollar, but always remember, gradually, then suddenly. And, not volatile ≠ store of value This is a critical mental block that many people experience when thinking about bitcoin as a currency, and it is largely a function of time horizon. While central bankers all over the world point to bitcoin as a poor store of value and not functional as a currency because of volatility, they think in days, weeks, months and quarters while the rest of us plan for the long-term: years, decades and generations.
Despite the logical explanations, volatility is one area that particularly confounds the experts. Bank of England Governor, Mark Carney recently commented that bitcoin “has pretty much failed thus far on […] the traditional aspects of money. It is not a store of value because it is all over the map. Nobody uses it as a medium of exchange,” (see here)The European Central Bank (ECB) has also mused on Twitter that bitcoin is “not a currency”, noting that it is “very volatile” while at the same time reassuring everyone that it can “create” money to buy assets, the very function by which its currency actually loses value and why it’s a poor store of value.
The lack of self-awareness is not lost on anyone here but Mark Carney and the ECB are not alone. From former Fed Chairs, Bernanke and Yellen, to current Treasury Secretary Mnuchin to the President himself. All have, at times, trumpeted the idea that bitcoin is flawed as a currency (or as a store of value) because of its volatility. None seem to fully appreciate, or at least admit, that bitcoin is a direct response to the systemic problem of governments creating money via central banks or that bitcoin volatility is a necessary and healthy function of price discovery.
But luckily for all of us, bitcoin is not too volatile to be a currency and often the experts are not experts at all. Setting logic aside, the empirical evidence shows that bitcoin has proven to be an exceptional store of value over any extended time horizon despite its volatility. So how could an asset such as bitcoin be both highly volatile and an effective store of value?
Bitcoin Value Function Revisited
Consider why there is fundamental demand for bitcoin and why bitcoin is naturally volatile. Bitcoin is valuable because it has a fixed supply and it is also volatile for the same reason. The fundamental demand driver for bitcoin is in its scarcity. To revisit bitcoin’s value function from a previous edition, decentralization and censorship-resistance reinforce the credibility of bitcoin’s scarcity (and fixed supply schedule) which is the basis of bitcoin’s store of value property:
While demand is increasing by orders of magnitude, there is no supply response because bitcoin’s supply schedule is fixed. The disparity in the rate of increase in demand (variable) vs. supply (fixed) combined with imperfect knowledge amongst market participants causes volatility as a function of price discovery. As Nassim Taleb writes in The Black Swan of Cairo: “Variation is information. When there is no variation, there is no information.” As bitcoin’s value increases, it communicates information despite the volatility; the variation is the information. Higher value (dependent on variation) causes bitcoin to become relevant to new pools of capital and new entrants which then stokes an adoption wave.
Adoption Waves & Volatility
Knowledge distribution and infrastructure fuel adoption waves and vice versa. It is a virtuous feedback loop and a function of both time and value. As value rises, bitcoin captures the attention and mindshare of a much wider audience of potential adopters, which then begin to learn about the fundamentals of bitcoin. Similarly, an appreciating asset base attracts additional capital not only as a store of wealth but also to build incremental infrastructure (e.g. more on-ramps & off-ramps, custody solutions, payments layers, hardware, mining, etc.). Developing an understanding of bitcoin is a slow process, as is building infrastructure, but both fuel adoption which then further distributes knowledge and justifies additional infrastructure.
Knowledge → Infrastructure → Adoption → Value → Knowledge → Infrastructure
Today, bitcoin is still nascent and current adoption likely represents \
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