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Discussions of BitCoin as the potential basis for a future global monetary system often point to the currency's price volatility as a shortcoming. Fiat currencies, by comparison, are (mostly) a lot less volatile. My question is whether an economy that relies on a low-volatility currency is actually preferable to one that is agnostic to currency volatility. The latter strikes me as more robust.
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Volatility has two sides of course, an upside (commodity or currency increasing in purchasing power) and a downside (decreasing).
When you invest in something as a store of value, you're always going to appreciate when it gains value as you hold it and dislike when it loses value.
Before you invest (EG, you have another money you're about to use to purchase it) you like when the price comes down so that you can get more of it (with the expectation of going back up again once you have it) and you dislike when the price shoots up prior to your purchase.
It is always a bad idea to price loans and contracts in a volatile currency, however. Since each party would be in a position to hope for an opposite swing direction, one party would always be inconvenienced by a change in value. Since loans and contracts are designed to offer joint utility, you don't want one party suffering or resenting the other party for their perceived unjust lucky gains: people would just avoid such contracts instead.
Today it is common to price items in USD then allow for spot payment in Bitcoin, for example, or to loan out money or establish contracts denominated in USD with sides paid by Bitcoin spot value. EG, I borrow $100usd from you today when Bitcoin is, say $100usd/BTC so you give me 1BTC. I pay you back later $110usd (principal + interest) but Bitcoin is in a dip when the contract matures so at $90usd/BTC I have to pay you back 1.222BTC.
And finally, while it is nice that Bitcoin appears to be on a long term up-trend, it's shorter-term volatility makes investments and contracts that can't hold out for the duration required to "get to the moon" much riskier and more difficult. Most Bitcoin-related business (including merchants, arbitrage, obtaining BTC and then holding to pay off payroll or suppliers and avoid paying multiple interchange fees) require maintaining balances in BTC over time and those balances may ebb or flow. Again, if you receive BTC on a rise (customer pays you; hey they get to choose the timing!) and have to pay it during a dip (regular payroll, running lower on parts than you can afford to wait for an upswing) then you are experiencing a significant capitol loss.
I understand why price volatility is currently a problem, but what I'm wondering is whether a future economy could have inherent protections against it, or even learn to thrive from it. I don't have a concrete suggestion for how to accomplish this, but I'm also not convinced such solutions are impossible. Here's an idea: what if every BTC priced contract came with two-way hedges (leveraged) against price volatility? That would reduce the risk but increase (slightly?) the cost of transaction. – None – 2014-02-14T09:13:49.800
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Yes, price volatility is a bad thing as it shakes peoples faith in the currency as a whole. The reason why money has value is because people use is in transactions. If people do not trust a currency, then they will be less likely to accept it as a form of payment.
This has me very worried about bitcoins as once 21 million coins exist, no more will be generated. This allows for extreme volatility as all a person would have to do to change the value of the currency is buy a large amount of bitcoins, print them out, and burn them. – Aaron Klap – 2014-02-14T20:45:14.790
So, why would that worry you? The value of the network would the be shared among fewer units. – Murch – 2014-02-14T21:21:59.247
@Murch Much like the near collapse of several US banks a few years back (great depression), it would shake peoples trust in butcoin as a form of currency. The government was able to step in and back the banks up. This was really a symbolic gesture, as it reestablished trust in the dollar. – Aaron Klap – 2014-02-14T22:33:34.807
Major difference here being, that the failing banks would have lost lots of funds of other people instead of only "burning their own". It doesn't really compare. – Murch – 2014-02-14T22:38:16.777
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Interesting question! Related: How does bitcoin's price volatility compare to commodities/stocks with comparable market capitalizations?, How to stabilize Bitcoin's exchange rate (reduce volatility)? Why aren't early adopters intervening in the market in order to stabilize the BTC price?
– Murch – 2014-02-13T13:02:43.947