Bitcoin's Increasing Acceptance By Traders Brings Problems

Early adopters of Bitcoin and true believers in the virtual currency face a dilemma, and it is one that will be familiar to many of us of a certain age and with a love of rock music. In the days before the internet brought easy ubiquity, finding a great new band was a thrill that filled people with the fervor of a convert. In 1980, for example, I went to see Talking Heads at the Hammersmith Palais in London and stumbled upon the support band at that gig, U2.

I ran around telling everybody how great they were and insisting that everybody listen. Gradually, not because of my efforts but just because they were good and their time had come, they gained in popularity. I, of course, started to resent their success. I saw them as having lost their edge and, the worst crime imaginable, as having sold out. Many Bitcoin enthusiasts are at that stage right now.

It is only natural that those that understand and embrace the concept of a virtual currency would wish to get out there and preach. They want to see Bitcoin fulfill its potential. The problem, of course, is that it is hard for anything that started out challenging the status quo to gain general acceptance without it, to some degree, being tainted by the popularity.

Unlike with a rock band, however, the potential problems that Bitcoin faces as it gains in popularity are not to do with staying edgy, in touch and relevant. They are issues that go to the very core of the currency. The financial system that Bitcoin originally challenged is increasingly embracing the once ostracized digital currency. At the very least, as Steven Lord puts it in an article at Futuresmag.com, the days of Wall Street dismissing Bitcoin out of hand are rapidly becoming history.

This is inevitable given the kind of volatility that gets traders excited and the increasing availability of derivatives such as futures and swaps, but is it desirable? What these products do is to give traders a way to trade BTC without actually owning the currency and for many that is the problem. It means that traders can easily short BTC and dont have to lend any price support by funding an account before starting to trade.

Most Bitcoin supporters have sufficient faith in free markets to accept this, and to understand that if BTC is to really survive it must take such things in its stride. If fiat currencies with their built in tendency to devalue over time can be freely traded, then BTC, with an inbuilt tendency to appreciate, should benefit from the same conditions.

That is true in the long term, but increased trading activity, particularly from institutions, does represent a problem in the short term. Instead of the value of BTC being about its worth as a finite commodity, and one with a decreasing rate of supply and increasing adoption, it becomes a function of sentiment. I can assure you as somebody who made a living in dealing rooms around the world for nearly twenty years, that trader sentiment is a fickle beast.

What those invested, emotionally, financially or both, in the Bitcoin market must understand is that as acceptance of the currency grows the volatility that we have seen this year is likely to continue, but it has no bearing on the ultimate value of the currency. I dont think well see the kind of massive run up and collapse that we saw at the end of last year, but there will be volatility within a trading band.

Currently that band looks to be around $300-$700, but that could change as it is still forming. If anything the trading band could move a little lower as new institutional traders come in. A 1 year chart such as that below would suggest downside potential, so testing the lows may be a tempting trade for newcomers with no exposure to the currency.

That doesnt mean, however, that those who have embraced Bitcoin should worry. They may wish to trade the moves to some extent, but if the world is ready for a currency based on a deflationary model, then the ultimate market pressures of decreasing supply and increasing demand will work their magic whatever traders do.

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Bitcoin's Increasing Acceptance By Traders Brings Problems