Background

The exchange rate of Bitcoin has reached record highs during March and April 2013. Despite a sharp decline from a short-lived high well above the 200 US$ mark in mid-April, the cryptocurrency has since recovered to a level of 140 US$ by the end of April. This still is tenfold the investment for investors who bought in the beginning of 2013. In May a sharp decline has started, the currency lost a third of its value in only three days.

Analysis

Recent legislation in the US [citation needed] seems to have increased investor confidence in the new currency and has sparked a buying spree. The debate on the actual fundamental value of the currency is undecided, and has become highly visible through its exceptional volatility.

Technical value of Bitcoin

Given that the supply of "mined" Bitcoin is limited, changes in demand (whether for liquidity and "investment") from the originally low levels have caused observably sharp swings in the exchange rate of the digital currency.

Fundamental value of Bitcoin

In the period before the recent price bubble, the moving average of the exchange rate rarely went above the US$20 mark. The mining of new Bitcoin will increase supply over time at a certain cost of computing power. As computer power is rising, this cost will go down over time. At the current exchange rate, mining activity can be expected to rise sharply.

Legal and institutional issues

BitFloor, a Bitcoin exchange, shut down on 17 April, 2013.

The largest exchange, Mt. Gox, was hit by a US$75m lawsuit from its prospective partner, CoinLab, on 2 May. [4]

Price fluctuations indicative of a design flaw

Only a total 21 million Bitcoin can be mined. [5] As Bitcoins stored for liquidity purposes cannot circulate, dead capital will increase with user numbers, tendentially pushing the exchange rate up but also making it increasingly volatile. For gambling purposes and media attention, this effect may be attractive. For payment purposes however, systematically fluctuating purchasing power of a curency is highly negative. This erratic effect might lead to the development of a more efficient digital currency. As the likely success of this (unknown) improved system becomes clearer, stored Bitcoin will flood the market and its price will go back to zero.

Exchange rate chart

Source: Bitcoin Charts

External links

1. Wikipedia article: Bitcoin
2. The Bitcoin wiki
3. Exchanges: Exchange rates at Bitcoin markets
4. Massive Bitcoin Business Partnership Devolves Into $75 Million Lawsuit - Gawker, 2 May 2013
5. Bitcoin wiki: Controlled currency supply