The wealth transfer effect of bitcoins

What really caused the value of bitcoin to skyrocket back in April, when the price per BTC shot up to a record high of $266? Was it really because of Cypriot banking controls, where a number of uninsured accounts were lost? Or was it simply the idea that the banking industry could wield so much control over the finances of people that caused bitcoin to go up? Could it be that a wealth transfer effect, where people move from a fiat currency into bitcoin was happening, and continues to do so?

A historical look at prices

Entering the first part of March 2013, the price of bitcoin held in the $30 range. But that didn’t last long: volume caused the price level to move quickly into the $40 range, and it wasn’t long before it was close to $50.

Keep in mind when looking at the following chart that it was 16th March 2013 when it was announced that Cyprus was getting a $10 billion bailout from the International Monetary Fund and the European Central Bank. That day was a Saturday, traditionally a slow-moving day for bitcoin exchanges, but you can see the price broke through the $50 barrier during the beginning of the next week.

During this time, Bloomberg Businessweek published an article titled “Fleeing the Euro for Bitcoins”. In it, the author suggested that bitcoin was like an app for avoiding the banking system. Many investors read this and likely considered the possibility of investing in bitcoins. Thus, a wealth transfer effect appeared to be taking place where money was being put into bitcoins.

In the time since, bitcoin has reached new levels of awareness. But that awareness has not been reflected in the price. In fact, the price of a bitcoin has stayed in a more stabilized price support level since the days of March and April.

That’s important to point out since it is volatility that many associate with bitcoin. The sentimental possibility that the price could rise and rise and then drop still exists in people’s minds, which generates a degree of skepticism for the currency in its long term outlook.

It’s entirely plausible that what we’re seeing is a slower version of a wealth transfer effect into bitcoins. The network has an interesting supply-side element to it, as there are early investors and miners who are frequently selling bitcoins.

And there are investors who believe in it more soundly as time goes by. Investor and entrepreneur Roger Ver shared this sentiment with CoinDesk at the Bitcoin 2013 conference in May. When asked about the possible risks in the technical stability of the Bitcoin network, he said that, as time goes by, the threat of such a scenario fades. “There is a risk of that,” Ver acknowledged. “But as every day goes by that there hasn’t been a major catastrophe, [the risks] are lower and lower.”

Indeed, in the days when bitcoin’s price went up and then went back down, it might have been more to do with the growing pains of bitcoin’s largest exchange rather than the network itself. Mt. Gox has experienced a number of problems as one of the most popular exchanges, from hacking attacks to drawing the ire of regulators.

It’s important to see diversity in the bitcoin marketplace, and it appears that bitcoin investors have decided that Bitstamp is a reasonable alternative as an exchange to Mt. Gox. That comes after record highs in volume caused Mt. Gox many problems and got investors thinking about exchange alternatives.

Looking ahead

If historical events are any predictor of future results for bitcoin, it is difficult to dismiss what happened to both bitcoin volume and price earlier this year. It is commonly known in financial circles that investors in stocks and bonds as a result of a credit degrading feel significant wealth transfer effects.

In the case of Cyprus, its own credit rating was downgraded to ‘junk’ status in March of 2012. But it took another year before we saw the events that transpired when the country was provided an influx of cash and capital controls were enacted. Cyrpus’s credit rating was lowered even further in January of 2013, with Moody’s warning that the government there might default outright.

So it is perhaps not inflation, or government control, that dictates a wealth transfer effect into bitcoins as we all witnessed earlier this year. In fact, these pricing swings might actually come from the lack of full faith and credit in governments. Earlier this year, I wrote about a number of countries that would do well by adopting bitcoins, mostly because of either inflation or poor investment options in those countries.

Those are still valid reasons for investing in BTC for citizens of those countries. But it now seems that in hindsight it would be a complete governmental collapse that would fuel increased interest in bitcoins. A loss of faith in a monetary system by a country’s citizens and stakeholders is likely more of a predictor of increased interest in bitcoin.

Countries that are credit risks

So, what are the countries out there today that face big problems in terms of credit risk? Egypt is one country that has had its share of unrest, and it is a place where people have not had faith in their government for some time.

Egypt has put in place capital controls to limit transfers of money outside of the country over the amount of $100,000 according to the US Department of State. A complete collapse of rule of law in Egypt could result in capital flight – if it is even possible to get money out. Recent reports claim that Thailand has declared bitcoin illegal in order to better control capital flight that could happen there as a result of unrest.

What do you think? Is it a loss of faith in governments that causes a wealth transfer effect into bitcoins? What caused the price to spike to $266 in April? Share your views with us in the comments.

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