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Many people will not touch bitcoin due to it's historically extreme volatility. Many new currencies have pegged their value against an established currency until such time as it is sufficiently established to be decoupled.

For example the Irish punt was linked to the Sterling pound until they joined the European Monetary Union in 1979.

Would it be possible perhaps by way of a financial service organisation that guarantees a value against a stable currency such as the swiss franc for example, this using bitcoin as a form of promisory note?

Is the agreement of a fixed rate against an established currency like type of future or option in the stock market?

I think this could help speed adoption.

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You could fix the minimal value of Bitcoin if you had some money and you wouldstate: "I have X$, I will buy each and every Bitcoin you offer me at the rate of X/2100000$". The only problem is that people need to trust you and you have to have enough money. So, if you get en established company (for example, Google) to secure the funds you can fix the minimum price of Bitcoins at any arbitrary rate.

Fixing the maximum price, however, is impossible, as you can't generate Bitcoins at a whim to sell to anyone offering you money. As with anything with limited supply, the sky is the limit.

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  • I think a fractional reserve would be possible :-P
    – barrymac
    Oct 26, 2011 at 17:03
  • @barrymac the problem with fractional reserves is that they can only inspire fractional confidence. In other words, if I guarantee that I'll buy bitcoins for $1 each but I only have enough money to cover 10% of the total bitcoins in existence, there is still a chance my reserve could be bought out and allow sub-$1 prices. Anything shy of 100% backing can inspire some confidence, but in my opinion at least, not enough.
    – David Perry
    Oct 26, 2011 at 18:38
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    @barrymac - well, if you would have enough people doing fractional reserve, eventually you would back up the coins in 100%. Then again, the more people that claim they will buy Bitcoins for X$ per coin, the higher each coin is worth. You can establish some network of trusted entities that would pool their resources and thus establish a higher minimal value of Bitcoins (for example, having X$ and Y$ from two people, each coin would be worth (X+Y)$/21M).
    – ThePiachu
    Oct 26, 2011 at 18:55
  • @David Perry I take it you don't trust your bank very much then either! I can understand that, especially given recent events
    – barrymac
    Oct 27, 2011 at 11:30
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The only way to fix an exchange rate is to constantly trade at this rate. This requires unlimited funds.

So assume you want to peg BTC against CHF as in your example. For simplicity, we aim at 1 BTC == 1 CHF. Here's a simple recipe.

  1. Have unlimited Bitcoin and unlimited CHF.

  2. Find a Bitcoin exchange.

  3. Offer to buy an unlimited amount of Bitcoin for 1 CHF/BTC.

  4. Offer to sell an unlimited amount of Bitcoin for 1 CHF/BTC.

  5. Observe how everyone will accept 1 BTC/CHF as the official rate.

  6. If you run out of Bitcoin or CHFs, give up.

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Unlike any other fiat currency, bitcoin money supply could not be manipulated, therefore it's not possible to fix its value in any way but good old buy and sell orders which would require a very heavy investments.

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  • It's probably possible to calculate how much capital that would require as a function of the current market volume. Any ideas?
    – barrymac
    Oct 26, 2011 at 16:38
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    Take a look at "Bot to operate a price bloc to stabilize price of BitCoins" - bitcointalk.org/index.php?topic=39792.0
    – Serith
    Oct 26, 2011 at 16:49
  • @barrymac look at BTC Watch in the top left corner you'll see "Total BTC" - multiply that number by the price you'd like to guarantee (we'll call it n) BTC does not dip below and that's how much money you need. 7200 new coins are mined per day so add 7200n dollars per day for a number of days to ensure they stay backed for the foreseeable future.
    – David Perry
    Oct 26, 2011 at 18:40
  • ...or at least, that's an upper limit on how much money you would need. In practice you share the "load" of guaranteeing the bitcoin with any other people willing to value the bitcoin at this level, and repeatedly blocking any dips with massive, massive buys will tend to make the market at large pretty confident about that bottom.
    – eMansipater
    Oct 27, 2011 at 2:28
  • The discussion about using a price bloc bot network is very interesting!
    – barrymac
    Oct 27, 2011 at 18:48
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I think that trying to tie the value to some arbitrary standard is artificial - for one thing, the value may depart substantially from that other standard and needs to be allowed to vary in order to stablize at an authentic (ie reflecting supply/demand etc) rate.

However, reducing extreme volatility would indeed make BTC more appealing as a medium of exchange or investment. The extreme volatility seen in June was due to illiquidity of the bitcoin market in the face of a sudden increase in demand. It's just like a 'penny stock', where few shares are traded and there is no market-maker or institutional investor.

Picture a cup of ice cubes, vs the same volume of water. If you add or remove the same amount of water, the level in the ice-cube cup will jump in increments, vs the level of liquid water varying smoothly.

Liquidity of the BTC market would improve if many traders were always present to make small transactions on mtgox, and if several institutions or big investors would step in to 'make a market' in bitcoins. Making a market would require holding a BTC reserve large enough to satisfy most requests to buy OR sell BTC in a current day. Examining bitcoincharts.com, we see this would mean holding about 250K BTC each. The market maker(s) simply post active Bids and Asks slightly wider than the spread, so they are always making some profit just buying and selling.

It would also help if the bitcoin exchanges consolidated to one, or what will happen is someone will build arbitrage bots which exploit 'flipped markets' - eg situations where a bid on one exchange is higher than ask on another exchange.

Thirdly, it would help if a venture fund existed to invest in businesses which accept BTC payments or build BTC technology... people would then invest in that fund and act to protect their interests in BTC succeeding. I am working towards creating such a fund but can't talk about it yet.

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The larger issues isn't can it be done it is why would anyone do it.

Central banks buy and sell opposing currencies to keep the value pegged. Generally speaking they lose a ton of money doing this however it provides a public good and being a central bank they can simply create or destroy sufficient money to accomplish the goal. Any losses the central bank accrues or gains are simply felt by overall economy via inflationary and deflationary pressures.

There is no central bank thus any entity which tried to do this would be facing significant and continual real losses for no benefit. Sure the entire Bitcoin economy benefits but that isn't something that can be monetized by the entity taking the risk/losses.

The only situations that even seems possible is some benefactor who willingly suffers massive and continual market losses to provide a narrow trading range for Bitcoin and that isn't very likely.

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  • " Generally speaking they lose a ton of money doing this however it provides a public good" - I don't think it can be stated as a fact that it's a public good. A public good is defined as one that can only be provided by collective action. Reducing risk from price volatility can be achieved by individual market participants through the use of options and futures contracts.
    – Amin
    Oct 27, 2011 at 8:37
  • Indeed the massive and continually growing currency reserves that governments of many large economies is seen by some leading economics as a failure of modern money systems! For example the way china supports the dollar, fed prints dollars, china buys them to keep it's exports strong. crazy.
    – barrymac
    Oct 27, 2011 at 11:13
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The main "obstacle" for this idea is that few people would like it. The central advantage of Bitcoin is that it has no central point of failure - or at least not single organization that is liable for it. With a peg, there is necessarily an organization that is liable to maintain the peg - they have to keep their promise.

So if Bitcoin were pegged in such a way, it would be no better than prior digital currencies like Beenz or egold.

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The easiest way to immediately see why this would be extremely difficult, if not impossible, is to imagine this: Suppose you decided that the price of an ounce of gold today in dollars (or relative to a bundle of goods, or whatever) was the perfect price for gold. What could you do to keep it stable?

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Instead of pegging the currency use futures or options to cover a potential drop in value (hedging). A well trodden path. As everyone expects bitcoins to go up over time and it is quite volatile would make the cost of hedging low. It would be interesting if a website provided this service on easy to understand terms.

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  • Is this an answer to the question?
    – Jestin
    Jul 25, 2016 at 13:27
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Bitcoin value is based entirely on speculation, specifically on the expectation that its price in an established currency will rise indefinitely. The instant that it has its price in an established currency fixed, or that concrete items are priced in Bitcoin, that expectation is destroyed. So it's hard to imagine where the support for this would come from, unless it is sought as kind of bailout for holders who are concerned that they face losses without it.

Think of Bitcoin as shares of stock in nothing (or perhaps, shares in a virtual utopian libertarian project). As long as those shares, for whatever reason, are expected to increase in price as denominated in actual currencies, people will buy Bitcoin using those currencies. Pegging the price of those shares is like suddenly converting those shares into shares in an actual company: it is now clear what they are actually worth. That's not something that would be appealing to many holders of Bitcoin.

But more importantly, what would the mechanism be? Who would guarantee and enforce the peg? If a government were to do it, it would essentially amount to a bailout of Bitcoin holders, since the actual value of Bitcoin is zero, money would have to be transferred from the real economy or printed to do that, or taxes would have to be levied. The irony of that might be lost on Bitcoin holders, but not on citizens or central bankers, with whom the idea is also not likely to be popular.

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