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Betting on Bitcoin. Fundamentals vs Technical Analysis.

There is growing interest in bitcoin and a dramatic increase in volume on the
largest usd<->btc exchange, mtgox.com

With it, there is increasing technical analysis being done, with the most noted
by user s3052 (http://blog.bitcoinwatch.com/) whose predictions have been
generally accurate.

However, there is a lot of criticism that bitcoin is too low volume and too
unlike other currencies/commodities to be subject to traditional technical
analysis. That may be. I am not an expert (or even a hobbyist) when it comes to
markets in general, so I won't really comment on the validity.

I will say though that fundamentals are at least as important as technical
analysis in determining trends in markets, and with bitcoin I am going to go
out on a limb and say it is even more important.

Bitcoin as a currency, or store of value, is unique in history in that there is
no objective backing in terms of commodity or decree by government that
gives it value. It's valuable only insofar as people *want* to use it as a
currency.

Thus, bitcoin derives it's 'market cap' from a siphoning from other currencies.
If and when people choose to convert their USD (or other currency) to bitcoin,
the existing market essentially undergoes slight inflation to compensate for
the increasing market cap of bitcoin.

Right now, these effects are small.. measured in dollars the 40M market cap of
bitcoin (today 4pm EST 05-15-11) is negligible to the US economy. As this
market cap increases (if it does) the increased purchase power of *all bitcoin*
has to "come from somewhere" which is literally the other currencies it is in
competition with.

This is a unique property of bitcoin in terms of markets, and why I think the
upside of bitcoin is far far higher than the nearly $9 highs we saw before the
significant correction yesterday.

The general picture of competing currencies is two monolithic entities
competing for relative value over each other; each with their own internal
purchasing power.

The picture with bitcoin is different. Instead we have these little blips of
bitcoin markets existing *within* the existing economies, slowly growing in
terms of purchasing power (but so far the purchasing power is growing at far
greater a rate than the size of the bitcoin economy measured in BTC supply).
These little economies, as they grow, parasitically pull value into bitcoin as
a whole.

If and when confidence grows in bitcoin maintaining its purchasing power, the
convenience and security will encourage more and more users, thus further
increasing BTC purchasing power at the expense of its hosts' economies.

The market cap of bitcoin will always generally reflect the relative purchasing
power that holders of BTC estimate bitcoin as a whole has. This purchasing power
includes other currencies, as well as goods and services.

Bitcoin, due to its limited supply, will have to continue to undergo deflation
to absorb the increase in confidence of bitcoin's purchasing power.

With that in mind, any type of wide adoption of bitcoin would put the market
cap of bitcoin in the billions or more, putting the upside relative to current
rates extremely high.

This is the reason I am relatively unconcerned with the speculative nature of
today's bitcoin market. In a traditional bubble, buyers buy on the hopes that
other buyers will purchase still higher; relying on trends and groupthink to
make their profits. The bubble pops when finally the fundamentals catch up to
the profits/utility of the underlying commodity; eventually it cannot deliver at
the necessary rate to justify the high costs incurred due to the speculative
bubble.

Bitcoin is different in that early speculators are essentially *betting* on the
eventual acceptance of bitcoin to some degree. This brings us out of technical
analysis territory and back to fundamentals.

Since there is already some degree of trading happening with bitcoin (I have
gambled, bought computer parts, paid for coding, and sold shirts for bitcoin),
the question is really whether or not bitcoin will a) have a catastrophic
failure, b) remain a niche currency for a very small subset of geeks, c) slowly
fade away into obscurity, or d) reach some wide level of adoption.

a) and d) seem to be, combined, the most likely scenarios by far. I believe b)
and particularly c) are pretty unlikely.

I find b) unlikely because the black market will continue to find significant
value in bitcoin, thus propping up demand enough for BTC where people are
encouraged to exchange goods and services for BTC. (particularly people who can
do skilled work from places that traditionally have very little market for that
work)

Then c) is even more unlikely just looking at the trends for bitcoin. Nothing
about it indicates a trend toward obscurity; at least not until something
better comes out. More likely it will fail spectacularly than simply fizzle
out.

Considering a pure-failure or pure-success scenario; this is essentially where
I see the consideration to be made in whether or not to bet on bitcoin. (Full
disclaimer, i hold a small number of bitcoins and am betting long).

Scenarios for failure have been discussed elsewhere, but essentially come back
to an inability to scale, and government intervention.

In my estimation, scalability is no where near an imminent threat, and I am
confident if bitcoin *needs* to scale to be on the level with VISA/Paypal;
infrastructure will have improved significantly, and efficient implementations
will be successful. (See https://en.bitcoin.it/wiki/Scalability for more
discussion)

Government intervention is probably the most serious and most imminent threat;
but the likely attack vectors would be currency exchanges themselves; rather
than the currency proper. This would have, at the moment, a catastrophic effect
on the confidence of bitcoin; as it would make it much more risky and
inconvenient for merchants to accept payment when they rely on converting their
BTC to USD to cover costs.

However, I don't think bitcoin is a near serious enough threat for the
government to take action just yet. As well, the window of opportunity for the
government to nip this thing in the bud is fast-closing; there are already
competing exchanges being set up on 4 more continents that will allow liquidity
between bitcoin and other currencies. By the time these are up and active; I
believe the US will have lost its opportunity to stifle the network.

Other countries' citizens have even more to gain than the 'rich' countries
citizens do from bitcoin; namely because it allows virtually frictionless entry to
more lucrative markets than their local markets.

As such, the only real threat I see to bitcoin *not* becoming adopted to the
level of paypal/visa at some point in the future, is government intervention in
a small window of opportunity that I don't expect them to take advantage of.

Thus, I conclude that betting long on bitcoin adoption is seriously +EV. Not
just in term of converting USD to BTC as a store of value, but for merchants to
accept bitcoin *now* in the likliehood that BTC will increase in value over
time.

Granted, one should not have to be a currency speculator in order to conduct
business, and that's unfortunately a pre-req to doing business in BTC at the
moment**. But entrepreneurs especially should not ignore this opportunity as
taking on the additional risk of accepting BTC can have a tremendous upside.

By ignoring bitcoin, not accepting bitcoin, and not buying/mining bitcoin, you
are effectively betting *against* the adoption/acceptance of bitcoin as a
currency/store of value. In light of the facts in the recent months (total
number of bitcoins sent per hour, total trade volume at mtgox measured in usd,
number of accepting vendors) I have yet to hear a compelling reason why BTC
doesn't have the 5-10% chance at reaching adoption necessary to make buying BTC
at todays rates extremely +EV.

Comments at: http://news.ycombinator.com/item?id=2550717

**In theory, with low enough volume in btc (say $10k/day) and reserves of
bitcoin equal to one days estimated volume; you could accept bitcoin at the
current ticker values and convert within seconds to usd; effectively removing
currency speculation while still allowing users/cusotmers to purchase in
bitcoin.