The Impact of Change in Prices on Bitcoin's utility as Currency

[webtricks]

One of the biggest on-going debate about Bitcoin is whether it can be used as currency or is it just a sort of investment? On the micro level, Bitcoin can surely be used as a currency. Since it has value, it can easily solve the problem of double-coincidence of wants by becoming the medium of transaction. But when we consider it at macro level, the story doesn't remain the same. There are several factors come into play when we consider the whole community, the prominent of which is Change in Prices.

The main reason why people won't use Bitcoin as currency is because its value (I'm not talking about fiat value but the real value) in the eyes of investors keep changing radically. Hence making sellers hesitant to accept Bitcoin as payment and buyers hesitant to spend Bitcoin for payment.

I have created following graph to show the impact of Change in Prices on the people's tendency to spend Bitcoin as payments:

CHART #1



Explanation: The above graph assumes that x number of Transactions (for payment purposes) take place when the price of Bitcoin is y. Now two things can happen, either the price of Bitcoin can increase or the price of Bitcoin can decrease. Both  cases can impact the normal behavior of holder. In the case of price rise i.e. increase from y to 2y, bitcoin holder will become optimistic that prices will increase further, this will lead to fall in number of transactions where bitcoin is used for payment purposes from x to x/2. Similarly, in case of price fall from y to y/2, holder may postpone his expenditure or may use other form of payments like general fiat currency for expenditure purposes in the hope that prices of Bitcoin will rise again. Therefore, the number of bitcoin-payments will decrease to x/2.

Overall Outcome: Higher the change in prices, lesser will the use of Bitcoin for payment purpose.


When we talk about Bitcoin prices, another topic comes to play i.e. Speculation! The above chart clearly shows the impact of current prices on Bitcoin's utility as currency but what about the future price? We all know that Bitcoin community loves to speculate. Hence, the speculation also have considerable impact upon the bitcoin's utility as currency. This brings us to our second graph:

CHART #2


Explanation: Unlike the chart #1, future expected price rather have two-ways impact on the number of times Bitcoin is used for payment purposes. Suppose Bitcoin community is expecting the increase in price of bitcoin in coming months. In such case, rather than spending bitcoins for payment purposes, people at large will hold their bitcoins. In other words, if the price increases from y to 2y, the transactions will fall from x to x/2 (it could be anything but I took 50% fall for the sake of simplicity).  Vice-versa, in case if people are expecting the fall in the prices of bitcoin, they may rush to spend bitcoins for utilities. This may pump the number of transactions from x to 2x.

Overall Outcome: If the future expected price of Bitcoin is higher, lower will be the use of Bitcoin for payment purpose. On the contrary, lower the future expected price, higher will be the use of Bitcoin for payment purpose.

[hatshepsut93]

Explanation: Unlike the chart #1, future expected price rather have two-ways impact on the number of times Bitcoin is used for payment purposes. Suppose Bitcoin community is expecting the increase in price of bitcoin in coming months. In such case, rather than spending bitcoins for payment purposes, people at large will hold their bitcoins. In other words, if the price increases from y to 2y, the transactions will fall from x to x/2 (it could be anything but I took 50% fall for the sake of simplicity).  Vice-versa, in case if people are expecting the fall in the prices of bitcoin, they may rush to spend bitcoins for utilities. This may pump the number of transactions from x to 2x.

Overall Outcome: If the future expected price of Bitcoin is higher, lower will be the use of Bitcoin for payment purpose. On the contrary, lower the future expected price, higher will be the use of Bitcoin for payment purpose.

You're saying that community expects some price changes, but that's a very bold assumption. In the long run everyone here expects Bitcoin to grow, in the short term no one knows and doesn't care much. You're also forgetting that whenever people buy stuff with Bitcoin, they can immediately buyback the coins with fiat. There can be situations when this is optimal, for example to avoid large fees on fiat transactions.

[The Sceptical Chymist]

You're also forgetting that whenever people buy stuff with Bitcoin, they can immediately buyback the coins with fiat.

Yeah, but why even bother doing that, especially if what you spent bitcoin on could be bought with fiat instead?  That never made any sense to me, the spending of bitcoin for the sake of spending bitcoin. 

The thing is that in order to use bitcoin as a currency, first you have to acquire it.  For the typical person that means going out of their way to buy it on an exchange with a bank account.  It creates a taxable event, too, which requires the buyer to keep track of the purchase price and the price when it was spent.  It's an accounting nightmare if you want to be compliant with the law.  Who in their right mind would want to do any of that when they could just spend their fiat instead? 

The price volatility is secondary to all of the above issues, though it is a real concern and one which keeps bitcoin owners holding their bitcoin instead of spending it.  These reasons are why I rarely ever spend bitcoin on something unless I happen to have bitcoin and don't have fiat.  The last time I did was maybe last year.

[webtricks]

You're saying that community expects some price changes, but that's a very bold assumption. In the long run everyone here expects Bitcoin to grow, in the short term no one knows and doesn't care much. You're also forgetting that whenever people buy stuff with Bitcoin, they can immediately buyback the coins with fiat. There can be situations when this is optimal, for example to avoid large fees on fiat transactions.

Since TP has very well explained the second part of your question in the post above this, I will concentrate on the first part of your question.
Not everyone is HODLer and intent to hold Bitcoin forever. Try asking people and you will find that around 20-30% traders are only doing day-trading. Most of the people like me keep buying and selling Bitcoins according to change in the market price. I sometimes use Bitcoin to renew hosting or buy domains etc. Namecheap is one popular provider that accept crypto payments. Hence from my own experience I can tell you that when I expect Bitcoin prices to remain constant or fall in near future, I don't hesitate to spend it for utilities and assume it as cash equivalent. But when the prices are rising and are expected to rise further, I restrict myself from spending and instead accumulate it.

[odolvlobo]

I feel that you showed how changes in price may affect the use of Bitcoin as a currency, but not the utility. Although, I guess you could argue that they are ultimately the same.


I think the effects of inflation and deflation on spending are well-known. It is certainly the case that when a currency starts losing value, people save less and spend more quickly. In the case of hyper-inflation, people tend to spend any money the get immediately, and that behavior causes the value of the money to drop even more quickly, due to the increased velocity.

Likewise, deflation causes the opposite to happen. When a currency starts gaining value, people tend to save more and spend more slowly. In the case of hyper-deflation, people tend to save as much as they can, and that behavior causes the value of the money to rise even more quickly due to the lower velocity.

I consider Bitcoin to be hyper-deflationary currently, and I believe that state will come to an end eventually. Once a saturation point is reached and the price levels out over the long term, people who were previously saving will start spending.

[hugeblack]

Price volatility is a short-term problem and volatility may be reduced once the market capacity reaches trillions of dollars. It's a matter of time.
About the acceptance of merchants, merchants can indirectly accept Bitcoin payments "using any third party."
the third party accepts payments in BTC and sends money in cash to merchants (Increasing BTC spending and reducing volatility risks.)

These third parties could use Bitcoin as an investment.

[gantez]

Simply, I think it can be used for both, that is; as an investment and currency depending on the person. I can invest in bitcoin by buying and hodling for it to appreciate and then currency, also as exchange for further coins or money as the case maybe.

[hatshepsut93]

Yeah, but why even bother doing that, especially if what you spent bitcoin on could be bought with fiat instead?  That never made any sense to me, the spending of bitcoin for the sake of spending bitcoin. 

There can be cases when it would be smarter to buy BTC and pay with it instead of using fiat. This happens when there are huge transactions fees for fiat methods, when you don't trust payment methods to deliver the payment, when itransaction is impossible due to regulations.

The thing is that in order to use bitcoin as a currency, first you have to acquire it.  For the typical person that means going out of their way to buy it on an exchange with a bank account.  It creates a taxable event, too, which requires the buyer to keep track of the purchase price and the price when it was spent.  It's an accounting nightmare if you want to be compliant with the law.  Who in their right mind would want to do any of that when they could just spend their fiat instead? 

The whole premise of Bitcoin is that it is a holdable currency, unlike fiat. Fiat is constantly losing value, and when you store it in bank there's a risk your money will be taken away (though this risk is quite low for general population). So, people who will use Bitcoin as a currency would likely be the ones who also use it as a store of value.

[figmentofmyass]

You're also forgetting that whenever people buy stuff with Bitcoin, they can immediately buyback the coins with fiat. There can be situations when this is optimal, for example to avoid large fees on fiat transactions.

i think very few people immediately rebuy the coins they spend. the data bitpay has released supports the idea that people spend bitcoin as a profit-taking measure after price rises. in other words, even the spenders are speculators!

The more valuable bitcoin has become, the more people are using it to buy stuff.  ”We have definitely seen a ‘wealth effect’ pattern when the bitcoin price increases,” says James Walpole, BitPay’s marketing manager. In other words, if you already owned bitcoin and it rose in value, selling some bitcoin would give you more dollars to spend.
https://qz.com/931810/cheapair-and-bitpay-data-show-rising-bitcoin-btc-payment-volumes/

[darkangel11]

It's hard to speak for other people but I spend only when I must and the higher the price the more I'm ready to spend some because I know that my coins will buy me more stuff.
If the average holder thinks like me all he wants is to have more BTC but sometimes a need to buy something comes up and he looks at the price and thinks that new computer is going to cost him 0.1 BTC but we are in a bear market, so maybe it's better to wait for a bounce back. Finally one day he sees a big green candle and Bitcoin is worth more than it was for the last 2 months. Maybe it's a good time to finally buy that computer. Now it's worth only 0.08 BTC so he gets to hold another 0.02. What if one day that 0.2 will buy him a new computer?

[Mometaskers]

Yes I definitely understand the hesitancy to use it as currency. Haven't experienced being on the seller side but when we have bear markets, we feel bad having to use it to buy less goods. When it's on a rally, we feel that we should be doing something else with it. Me and other users I personally know just end up watching the price, converting some to fiat when the price is good and just using those for purchases instead.

[youdacapt]

for macro conditions the use of bitcoin will enter a narrow space only for investment and naturally will form an exclusive structure, but on the other hand, many people will move inclusive, but for reasons of the middle economic cycle, will be used more as a currency. There will be a balanced point where prices will be higher because of the influence of demand, and currency utilities will also be more crowded in use with smaller nominal denominations.

[alyssa85]

Overall Outcome: If the future expected price of Bitcoin is higher, lower will be the use of Bitcoin for payment purpose. On the contrary, lower the future expected price, higher will be the use of Bitcoin for payment purpose.

This is why I think an alt like Doge or litecoin will get used for payment purposes. They can both scale because the blocks are found so quickly, and their value is pretty stable in dollar amounts.

[CryptoBry]

Overall Outcome: Higher the change in prices, lesser will the use of Bitcoin for payment purpose.

Overall Outcome: If the future expected price of Bitcoin is higher, lower will be the use of Bitcoin for payment purpose. On the contrary, lower the future expected price, higher will be the use of Bitcoin for payment purpose.

Volatility will always be a big issue not just with Bitcoin actually but generally with cryptocurrency except for the stablecoins. Many are seeing that this is the biggest hindrance for the future growth of Bitcoin as a currency, making it as more of a store of value in function. Though I have a concern on that: How sure are we that if Bitcoin can stabilize its volatility that people will really be flocking into Bitcoin, adopt it and use it everybody? Is there really a guarantee for that or are we not just making another speculation here?

Generally speaking, volatility has had been the biggest reason why many people bought Bitcoin in the first place. They don't care much about the technology behind Bitcoin or what makes Bitcoin tick in the first place. Speculations was the biggest reason why the ATH in 2017 and can be the same reason why there will be one in 2020. This why volatility can be a two-edged sword, a great advantage and a big disadvantage at the same time.

Maybe it is time to ask ourselves this very important question: How critical is Bitcoin or owning a Bitcoin while living in our modern and hi-tech world? Is Bitcoin providing us something that our lives would be radically different without it? If we are talking about payments or generally currency, is Bitcoin really irreplaceable that making transactions can be so hard without Bitcoin? The honest answers to these questions determine if there is really a big future ahead for this cryptocurrency...

[Wysi]

Yes I definitely understand the hesitancy to use it as currency. Haven't experienced being on the seller side but when we have bear markets, we feel bad having to use it to buy less goods. When it's on a rally, we feel that we should be doing something else with it. Me and other users I personally know just end up watching the price, converting some to fiat when the price is good and just using those for purchases instead.

Exactly, This is not limited to yourself but most of us feels the same way and that's the reason bitcoin cannot be used as currency because even when the value is at peak we don't risk to use it for transactions because we know about the volatility and cannot afford to lose if value dump, when we being in this industry from long time are hesitant to use it then how can we expect new comes or those with less knowledge about bitcoin into using bitcoin as currency for their daily uses.

[jseverson]

Yup, economics support this. Generally speaking, inflation spurs spending while deflation discourages it. This is also why fiat is inflationary by design.

This might be a tough pill to swallow to some people, especially those who believe that Bitcoin will one day destroy banks and replace fiat, but at the end of the day most people are only really going to use it where it's most convienient; cross-border payments, online transfers, etc. It doesn't necessarily have to be a bad thing though, because anyone can still use it for what they want to use it for.

[webtricks]

I consider Bitcoin to be hyper-deflationary currently, and I believe that state will come to an end eventually. Once a saturation point is reached and the price levels out over the long term, people who were previously saving will start spending.

That's true! The thing is Bitcoin's supply is currently hold by very less number of people, making it highly volatile. As soon as we will reach a point where supply is distributed among much more holders, prices will get stabilize with the daily fluctuation of just 0.05-0.1% and Bitcoin can be more widely used as currency.
However, I fear that the large number of transactions but the limited block size may act as constraint at that point.

Yup, economics support this. Generally speaking, inflation spurs spending while deflation discourages it. This is also why fiat is inflationary by design.
This might be a tough pill to swallow to some people, especially those who believe that Bitcoin will one day destroy banks and replace fiat, but at the end of the day most people are only really going to use it where it's most convienient; cross-border payments, online transfers, etc. It doesn't necessarily have to be a bad thing though, because anyone can still use it for what they want to use it for.

True that! Bitcoin was never visioned to be used as mainstream currency. It was designed as an alternative to mainstream currency with the additional features like privacy.
Here's what Satoshi have to say about it:

The current system where every user is a network node is not the intended configuration for large scale.  That would be like every Usenet user runs their own NNTP server.  The design supports letting users just be users.  The more burden it is to run a node, the fewer nodes there will be.  Those few nodes will be big server farms.  The rest will be client nodes that only do transactions and don't generate.

Besides, 10 minutes is too long to verify that payment is good.  It needs to be as fast as swiping a credit card is today.

See the snack machine thread, I outline how a payment processor could verify payments well enough, actually really well (much lower fraud rate than credit cards), in something like 10 seconds or less.  If you don't believe me or don't get it, I don't have time to try to convince you, sorry.
http://bitcointalk.org/index.php?topic=423.msg3819#msg3819

[mu_enrico]

I think if we view Bitcoin as a currency, change in price shouldn't affect the number of transactions (chart #1) that much because people will transact regardless of the price. For example, if I'm hungry, I'll buy food. It doesn't matter whether the currency that I use appreciates or depreciates. Also, don't forget about the liquidity preference theory in chart #2.

This kind of price vs. volume chart, usually used in the trading, or Bitcoin as a speculative asset.

So.. it's interesting to see whether the price movement is unaffected by volume or not, so you can make a case about Bitcoin as a currency or a speculative asset. This needs time series analysis though.

[figmentofmyass]

I consider Bitcoin to be hyper-deflationary currently, and I believe that state will come to an end eventually. Once a saturation point is reached and the price levels out over the long term, people who were previously saving will start spending.

but people tend to spend more as the price rises. doesn't that contradict your theory? it doesn't seem like everyone is waiting for some far-off price plateau. people seem to treat bitcoin like any other speculative investment in commodities or real estate---they hold until the price rises and then they sell. it's pure speculation.

we don't think of real estate investments in terms of deflation, do we?

[avikz]

Chart 1 Overall Outcome: Higher the change in prices, lesser will the use of Bitcoin for payment purpose.

Yes, because bitcoin market is a speculator's heaven! However, if you have seen the past trends, you must have noticed that whenever we enter bull's regime, the number of transactions increase. Because speculators rush to book their profit rather than using it as a payment for goods and services!

Overall Outcome: If the future expected price of Bitcoin is higher, lower will be the use of Bitcoin for payment purpose. On the contrary, lower the future expected price, higher will be the use of Bitcoin for payment purpose.

Practically resonates the same speculative behavior! If I am optimistic about bitcoin will touch 12k USD next month, why would I spend it to buy groceries? Rather I will hold it for now so that I can fetch the profit in near future!

I don't see such kind of behavioral trend as an issue because speculation is what keeping this market alive and dynamic. But we will definitely see more use of bitcoin as a payment method only if the price stabilizes!