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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.

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  • 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.
    – user4581
    Commented Feb 14, 2014 at 9:13
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Volatility is indeed a shortcoming for an asset to be the basis of a monetary system. Money aims to solve the problem of double coincidence of wants in barter by acting as a medium of exchange. And to do so, it must be an asset that everyone is willing to accept in payments, even those who do not demand to hold it for long. The more volatile an asset, the greater will be the spreads when traded against other assets, and hence the less convenient as a medium of exchange for those who do not demand to hold additional amounts of it, and will need to trade it immediately.

We should also note that people prefer to ensure their most immediate needs are covered before thinking about the future, so the demand for assets with a greater expected return in the long-run but greater uncertainty in their short-term value is smaller than that for stable assets. The wealthier you are, the further away in the future will be the needs you care about.

A volatile asset introduces friction in most trades, while the purpose of money is precisely to reduce that friction. In its function as a medium of exchange (MoE), it forces the exchanging parties to agree on two prices instead of just one —the price of the volatile MoE and that of the object traded for it—. And, in its function as a unit of account (UoA) it forces both sides of every contract to assume (or hedge) an additional exchange risk that they most likely do not want.

Bitcoin is an inherently volatile asset, useful as a censorship resistant tool to carry wealth to the future and to exchange it with others —this can overpower the inconvenience of its volatility—, but it does not have the qualities required to be the basis of a monetary system.

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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.

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  • 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
    Commented Feb 14, 2014 at 20:45
  • So, why would that worry you? The value of the network would the be shared among fewer units.
    – Murch
    Commented Feb 14, 2014 at 21:21
  • @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
    Commented Feb 14, 2014 at 22:33
  • 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
    Commented Feb 14, 2014 at 22:38
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It depends on how you think about it. Arguably Bitcoin will strongly incentivize people to think of the long term and discard the short term volatility in their perception due to the fixed supply. Similar to how we don't constantly worry about the weather being volatile, because we have adapted relatively well to it and it doesn't really impact our lives much. When it's winter and you want to take a swim in a lake, you simply wait a couple of months and then do so. Perhaps an incomplete analogy but hopefully the point is clear.

Another part of the equation is, that Bitcoin is a relatively new technology so volatility is expected and could go down in the future. If Bitcoin is a niche obsession, one big player entering the game has a big impact. If it's a globally dominant monetary system these swings will likely decrease.

The last argument would be 1BTC = 1BTC. Prices always change and the change in prices is not only expected, it is a signal necessary to assess the true state of the world. Artificial price stability through government control can be simply thought of as a lie. So if you count everything in Bitcoin, Bitcoin is just as volatile as the speed of light. If a car changes how fast it's going we don't consider the car as the universal measurement of speed. We take constants for that, and arguably Bitcoin is the first time we have a constant in the economic world.

So just because things change in relation to it, does not mean the thing itself is volatile.

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At this point, Bitcoin and crypto are highly speculative assets... excluding most stablecoins. Volatility is to be expected as its part of price discovery.

Long-term (10+ years), I think you'll see far less volatility as Bitcoin, Ether and more cryptos become widely adopted. And the leaders are designed to appreciate overtime. Bitcoin has a hard-cap on how many coins can exist. Ether is now systemically deflationary.

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