**iNVEZZ.com, Monday 9 December:**
On Saturday, the price of one bitcoin slumped to $576 on the prominent Mt Gox exchange after the Chinese internet company Baidu stopped accepting payments with the digital currency. Baidu, dubbed by the media as ‘the Chinese Google’, wrote in a statement on its website that the decision was made because of the enormous volatility of the crypto-currency.
The official announcement said that “due to the recent fluctuations in the price of bitcoin” Baidu was suspending with immediate effect the acceptance of the virtual currency for purchases of music services in order to protect the interests of users. The decision by the Beijing-based company is in response to the warning from the Chinese central bank published last Thursday, which implicitly banned financial institutions from trading bitcoins.
According to Ed Matts, senior technical strategist at Capital Management, “the Bitcoin Paradox is that it will not have a future if it remains so volatile”, because people will not trust such an unpredictable medium of exchange. While the spot price of gold has had its share of volatility this year, Matts observes that the precious metal has been established as an alternative currency for centuries and “it has nothing to prove in that respect”.
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The right chart below from the first report on bitcoin by the Bank of America Merrill Lynch illustrates that the realized volatility of bitcoin is more than six times the realized volatility of gold.`
David Woo, global head of rates and currencies research at Bank of America Merrill Lynch, also believes that “bitcoin’s role as a store of value is seriously compromised by its elevated price volatility”. Woo notes that the BTC/USD has fluctuated roughly 10 percent on a daily basis since its inception, including days when the price moved nearly 200 percent intraday.
There is an argument that these wide swings reflect shifts in estimates about the fundamental value of the digital currency as more and more people start to use it. Woo though believes that the volatility “is more likely a function of the highly speculative nature of the market which produces such unstable returns amidst very low circulation and poor liquidity as investors are enticed by the extreme return opportunities”.
Whatever the precise explanation, bitcoin’s high volatility undermines the crypto-currency’s role as a medium of exchange because, as Woo puts it, “large retailers are much less likely to accept it as a form of payment with prices so volatile”.
The left chart above shows how, over a given period (November 2011 through August this year), the number of e-commerce transactions was inversely correlated with the realized volatility of bitcoin. Stores and other retail outlets accepting bitcoin currently are effectively bearing the costs of this volatility and not passing it onto their consumers, but analysts at BofA Merrill Lynch do not expect this unprofitable tendency to last.
Viewed in that light, the Baidu rejection of bitcoin comes as no great surprise and other purveyors, in China and elsewhere, must now be considering their positions.
Since the weekend’s slide though, bitcoin has found renewed support and the BTC/USD currently hovers around $888.28, up 8.68 percent intraday.
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