Bitcoins and currency volatility

Last weeks, Bitcoins experienced high volatility in exchange value. While this instability is bad for merchants that use Bitcoins as a currency, a different kind of activity became suddenly very profitable.

The Euro currency and its bank system is designed to keep the price level stable. This goal is to be achieved by controlling the interest on loans that the Central Bank provides to commercial banks. There is no direct control of the Central Bank on the price level or, in principle, on the money supply side. The assumption is, that only a neutral stable price can reflect the existence of scarcity or surplus in the allocations of goods and services in a free market economy. In other words, the price mechanism cannot work properly if the price level is affected by inflation or deflation.

Such a free market economy, however, is a theoretical framework. A perfect price stability is difficult to accomplish in our imperfect world. Our economy has to experience, most of the time, inflationary or deflationary cycles. Nevertheless, a price that doesn't show a high volatility in the short run is much appreciated by merchants. It allows to estimate costs and profits for the future and help thus, to reduce uncertainly.

A couple of weeks ago, Bitcoin enjoyed a lot of attention by the traditional media. Many new people entered the Bitcoin speculation market and started buying and selling Bitcoins. The price of Bitcoin was affected and showed high volatility. That in spite of its deflationary nature. This quite unnatural behaviour in Bitcoin exchange value made transactions of goods for Bitcoin and vice versa, quite difficult. Webshop merchants had a hard time setting their prices in Bitcoins because they simple cannot use a fixed Bitcoin value in relation to currencies as Dollar or Euro.

However, while Bitcoins high volatility was annoying internet merchants, a different kind of Bitcoins economic players were, supposedly, enjoying high profits. When goods or currencies are experiencing a large range in exchange value within a very short time, “day trading” is a potential highly profitable activity. Buying Bitcoins at a low price and selling shortly after, when the price turns up, can be an easy way to make money. Every cloud has a silver lining...