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Think Big. Move Fast.

This week, the price of Bitcoin hit an all-time high of $266 and then a “flash crash” brought the price tumbling down to $105.  What happened?  The largest exchange Mt. Gox reported that it had seen dramatic increases in new account creation and executed trades, leading to long system lags.  At its worst, orders were taking more than an hour to execute, and panic led people to sell Bitcoin en masse.  Near the bottom, Mt. Gox then began experiencing a distributed denial of service attack (DDoS), where hackers continually hammered the exchange, hoping to cause greater system lag, thus causing an even greater sell-off.  Finally, in an unprecedented move, Mt. Gox halted trading for 12 hours as it upgraded its systems.  When trading resumed, prices were down 35% and have remained volatile – as of the time of this post they are down to around $75. This is still up 50% from where it was trading a month ago.

Some Bitcoin critics are saying “I told you so” and calling this the beginning of the end for Bitcoin, which they describe as a ponzi scheme. Mostly these folks are writing in Barrons, Forbes, and other publications, the same sort of places where people were calling Facebook a failure because prices dropped after the IPO. Silicon valley is more used to the wild swings and pivots of startups, whether companies or currencies, and takes a longer term view. Facebook built $65bn of value in 9 years, so what happened since the IPO is missing the point. Similarly, Bitcoin has grown to around $1bn in market cap in the last four years, so what happened in the last 48 hours also missses the point.

Bitcoin has had five crashes since it started, and five bull market runups before each one. Astute observers have noted that up until the latest crash, the price of Bitcoin had been doubling at an accelerating pace.  It took 21 days to double from $33 to $65, then 14 days to double from $65 to $130, and only 6 days to double from $130 to $260.  Acceleration in price increases at this rate could not have lasted more than another week, so it was just a matter of time before prices came crashing down.

It’s important to highlight that although prices have cooled off, the Bitcoin economy is alive and well.  Bitpay, a startup enabling merchants to accept Bitcoins as payment, reported that the company processed $2M in the first 25 days of March and ended the month at $5.2M processed.  Overall transaction volume continues to climb steadily. Transaction volume will always be the key driver of underlying value for Bitcoin, although speculation may run ahead of this underlying value from time to time, as it has recently.

Many in the Bitcoin community have noted that Mt. Gox’s transaction execution performance and recent downtime contributed to the volatility and panic selling. Their current trade execution time is extremely slow compared to any major marketplace – upwards of an hour or more at peak volume. Part of this is created by malicious DDOS attacks, part is due to deliberate price manipulation and scaffolding, but none of this is an acceptable excuse.  Will Mt. Gox be able to fix its operational issues before a new exchange can gain liquidity?  Growing exchanges like Bitstamp, Bitfloor, and the newly-launched TradeHill may be able to capitalize on Mt. Gox’s missteps.  But Gox still has the liquiduty today, and they understand the problems that they have to solve better than anyone. Wherever things end up, we are confident that the Bitcoin community will find solutions to these temporary setbacks and by this time next year, we’ll be seeing sub-second execution times on trades and more overall stability in the Bitcoin world.

Once we get to those sub second execution times, with the liquidity that we already see in the Bitcoin marketplace, we will have the fundamental requirements in place for merchants to be able to accept Bitcoin without taking meaningful currency risk. Once that happens I think we will see a lot more adoption of Bitcoin as a low cost payments mechanism, and this will drive the underlying value of Bitcoin up again in a much more sustainable way.

What do you think?