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Causes behind the Bitcoin Price Rally

author: Vitalik Buterin
published: 2011-05-15 21:09:21 UTC

Many are wondering why the prices of Bitcoin have shot up by over 1000% over the past month, and whether the increase is sustainable or merely a speculative bubble, liable to suddenly crash at any time. The Bitcoin economy is still a small one, and with its market depth of less than 15,000 BTC, an investor with a few hundred thousand dollars to spare could cause a massive price increase all by himself, thus creating a bubble. However, it is extremely unlikely that the market is being manipulated for large scale financial gain. The first reason for this is that it would be uneconomical: looking at the market depth, one sees that there are nearly 15000 bitcoins waiting to be sold, but only 6000 to be bought. Thus, any attempt to "cash out" on the bubble will send prices down far too quickly to recoup the original investment.

The second reason is that the spikes in Bitcoin trade seem to be genuinely correlated with public interest. There is now a considerably wider array of products to be bought with Bitcoin. Far more physical goods are available, and more services. Gambling has opened up as a niche since the takedown of three major poker sites. The GLBSE offers investment opportunities within the Bitcoin economy. I recently complained about the lack of food available for Bitcoin, since then BitMunchies has opened up, and is clearly succeeding enough to expand its business - since its opening the number of products available has doubled. Many others are reporting success. The I Use Coins T-shirt, for example, has had 45 sales, with a revenue of a few hundred BTC. It is extremely difficult, however, to tell the size of the bitcoin commerce economy - many transactions are done informally through the Bitcoin trade forum, rather than through a store. What can be said, however, is that the amount of commerce being done through bitcoin is growing. Regardless of whether it is commerce or speculation, the existence of public interest in Bitcoin, and its considerable growth since April 27, is clearly shown on Google Trends.

It is true that the Bitcoin trade volume of 1.7 million is much higher than the MtGox trade volume of 52000 BTC, but let us examine what most of this trade volume is. The 1.7 million volume is primarily caused by six transactions ranging from 230000-250000. Going to the block explorer at one of these transactions, clicking on "previous output" and "redeemed at input" (where the bitcoins in that transaction came from and where they were next spent), we see that the same coins are being moved around over and over again. The six last transactions were all made over the course of a single hour. Going back along the chain, we see that this money originated from this consolidation of mining revenues and many smaller transactions, and if one goes back far enough we see money leaving the chain in small chunks as well. Thus, the most probable conclusion is that this chain represents internal transactions done by MtGox. It is difficult to tell who the buyers are: it may be many small investors, while it may also be large buyers buying slowly so as to not buy out more than the market depth at any one time. What can be said is that it is more likely genuine buyers than a large-scale consipracy of speculators: the most recent spike in Bitcoin prices came right after a Forbes article on Bitcoin released in print on May 9. However, it was known beforehand that the article would come out then, so a smart speculator would have bought out the bitcoin before the article came, banking on a sale after the surge in interest pushes prices up.

There may still be powerful interests at play, and not of the Wall Street speculating variety. The Forbes article has been translated into many other languages, and a Russian version appeared on May 11. Looking at the Google Trends here, we see that Russian and Polish are dominant languages in the searches, while one of the dominant countries is Canada. Eastern European countries like Russia and Poland are widely known for their cybercrime activities, and Canada is becoming very attractive for cybercrime as a physical location for servers. The Bitcoin community has clashed with some Russians before; the owner of BtcEx admitted to a DDOS attack against MtGox, and he seems to be not well liked within the Russian community itself: this thread here has people demanding for him to allow them to withdraw the money that they put into the exchange. It is entirely possible that some of the Bitcoin is being bought for money laundering by a Russian cybercrime network. This is one of the niches of Bitcoin; the owner of BtcEx himself solicited Bitcoin donations to support the DDOS attack. This makes sense: countries other than the US currently have far too few bitcoin users for there to be a strong economy of physical goods, so most of the Bitcoin economy will have to be internet services. Although some internet services are legitimate - this article could easily have been written from Warsaw, Taipei or Vladivostok, unfortunately in the Russian language community one of the main internet 'services' is crime.

The block exploration shows that the majority of Bitcoin economic activity is converting it back and forth to dollars. However, the picture is not as bleak as it seems. MtGox's shuffling money around internally may be 90% of the transaction volume, but it is not 90% of the business - bitcoin commerce is more efficient than MtGox shuffling, with a payment consisting only of a single transaction from buyer to seller. And the majority of trade being currency exchange does not mean that Bitcoin is being traded mainly as speculation, Bitcoin stores trading their revenue for BTC would itself make the volume 50% currency exchange, and that is probably what Bitcoin-based businesses are actually doing, and will continue to do, while whe rest of their world runs on USD. There is another legitimate reason why the majority of transactions would be currency exchange: right now, the Bitcoin economy is growing faster than economic exchanges are taking place - ie. there are so many new entrants that for every 1 BTC that changes hands as payment for goods or services, there is more than 1 BTC that changes hands because new entrants to the economy need to have some BTC to get started. New entrants into the economy need to get their coins from somewhere, and the simplest way to do that is a currency exchange.

The most clear conclusion that can be drawn is that the rise in price is from genuine interest: spikes in buying match up to spikes in Google searches, the purchases made are small, the size of the bitcoin economy is definitely increasing. The fact that most of the trades are currency exchange trades is a natural consequence of the fact that the Bitcoin economy is growing, and very rapidly. This is, in the long term, a good thing for the economy: once the price consolidates and stabilizes, there will be a much larger demand for services and the number of stores that sell goods for Bitcoin will continue to increase. I am in full agreement with Bitcoin Market Watch: regardless of what happens in the short term, and in the short term a correction is inevitable (and may already be underway) since a commodity cannot remain stable with a 10% growth per day, the long term prognosis is a rally.

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