There’s a consensus among pundits that Bitcoin will never replace the dollar since it is too volatile. After all how can you price a cup of coffee if the value of the currency increases by 50% in an hour then back down by 15%? Nearly every critic of Bitcoin makes this point. Probably the worst offender is this article arguing that Bitcoin needs a central banker and nominating the retiring Ben Bernanke for the post. No that wasn’t The Onion, but rather the Washington Post.
The problem here is these people are being very short sighted. Sure Bitcoin is extremely volatile right now, but that doesn’t imply that it always will be. Let’s stop and consider a few points.
First, Bitcoin is still in beta. You might not have known that given the amount of money pouring in but it’s true. Version 0.9 hasn’t even been released yet and we are still a long way from version 1.0. It’s unreasonable to expect the price of a technology in beta, indeed the very first of its kind, to be stable. Surely as time goes by, as the technology matures, as it undergoes more peer review, it will become more stable.
Secondly, being a new (and extremely risky) technology with a tiny market capitalization, Bitcoin isn’t that liquid at the moment. A buy or sell order of just a couple million dollars will move the price by 10% or more. Couple that with a lot of amateur traders panic buying and selling and you have a recipe for wild swings in price. Yet, if Bitcoin achieves its potential it wont always be this way. As liquidity increases and professional traders become a larger part of the market, and as derivatives are brought to market, much of the volatility should subside.
Remember, in a free market the commodity that ultimately emerges a money will necessarily be the most liquid of all commodities. And once a commodity is established as money, the demand tends to remain fairly stable. Sure it might increase in localized areas during times of rising uncertainty (for example during a natural disaster) but during normal economic times it wouldn’t swing wildly like we’re lead to believe. The swings in the demand for money we currently experience are largely the result of the Fed generated business cycle, not the cause of it. So if Bitcoin becomes ubiquitous, volatility wont be a problem.
Also what the critics completely miss is that Bitcoin has a built-in mechanism for bootstrapping on the dollar until it liquid enough to stand as an independent currency. Because it is both cheaper and faster to send value using Bitcoin, it can be (and currently is) used as a payment system in the interim. If I want to send you dollars, I can convert the dollars to bitcoins, send you the bitcoins, and you can convert them back into dollars. That might seem awkward to send money that way, but the round trip would still be cheaper than most other means and certainly faster. If more and more people use it this way, the demand will rise, liquidity will increase, and volatility will go down.
So to sum up, it’s certainly fair to criticize Bitcoin for the present volatility, but it’s wrong to assume that volatility will be a permanent feature of Bitcoin. Completely replacing the dollar is an enormous challenge. If Bitcoin doesn’t succeed, however, it will most likely be for other reasons not perpetual volatility.