Bitcoin has not made headlines for quite some time; relatively calm price action and no exchange implosions have kept the digital currency on the back page. However, over the last week volatility has increased markedly. Within the span of a few days the price of bitcoin experienced two flash crashes. Most notably the BTC-e exchange price dropped from around $500 to $309 in a matter of minutes. The proximate cause was a block of 1550 bitcoins sold at the market. While nobody knows why the block was sold so rapidly, the move is consistent with a margin call.
Many exchanges are now offering margin trading on bitcoin, but they have yet to disclose how and when margin calls are issued. Additionally, probably more than any other market, bitcoin trading is dominated by automated trading bots. This means that price swings can be swift and violent once they trigger trading bot signals.
Since the flash crashes, the price of bitcoin has rebounded sharply, surpassing its high before the sell-off. Clearly market players believed that bitcoin at $309 was a great value and they scooped up coins on the cheap. This of course raises the question, what is the appropriate value for bitcoin? Like gold, Bitcoin does not have an intrinsic value. That is to say, it is only valuable if other people accept it for payment. This is where Bitcoin (and other digital currencies) have a huge advantage over gold – they are accepted as currency by an increasing amount of merchants. If you need proof, try buying something from Overstock with gold…not happening. But try buying it with bitcoins and within a few days you will have that shaggy area rug you coveted. To my mind, simply the fact that merchants accept bitcoin makes it more valuable than gold.
Following the logic of merchant acceptance as a driver of bitcoin value we can then view the growth in merchant acceptance as a proxy for the growth in the price of bitcoin. To be sure this will not be a linear relationship, but overtime we may be able to detect periods where the price is far from equilibrium. The following chart shows the rolling 30 day change in the price of bitcoins and the rolling 30 day change in the number of transactions.
The chart clearly illustrates that big changes in price are preceded by growth in transactions. In April 2014, the price of bitcoin bottomed at $400 and within two months the price jumped over +68% to $675. Notice what was happening to the amount of transactions in the three months before this price spike…yep there were increasing rapidly. A similar pattern occurred when the price of bitcoin hit a low at the end of June, transaction volume was increasing over the previous month.
As of August 21, 2014 the price of bitcoin has dropped over -20% since July (this is not including the flash crash). If we look at what has been happening since the middle of July 2014, transaction volume has been steadily increasing. If the pattern holds this could mean that bitcoin is about to make another move higher.
What is even more interesting is that the price of bitcoin begins its move higher when the growth in transactions begins to peak. One possible explanation is that as new merchants accept bitcoin they immediately convert to fiat currency. This temporarily depresses the price and creates an opportunity. Once the merchant conversions are complete the supply overhang is lifted and the price increases. Over the next 30 days we may have a real time look at how the price reacts when transaction volume decreases.