Silk Road proprietor: Bitcoin’s volatility doesn’t really matter

by on April 18, 2013 · 0 comments

2013-03-07_0113-4A couple of weeks ago I wrote that bitcoin’s valuation doesn’t really matter for the currency to effectively function as a medium of exchange. Now comes word from none other than the proprietor of the notorious Silk Road encrypted black market that indeed the recent wild volatility has not affected the transactions on his site. As Andy Greenberg reports:

In a rare (and brief) public statement sent to me, the Dread Pirate Roberts (DPR) said that despite Silk Road’s reliance on Bitcoin, commerce on the site hasn’t been seriously hurt by Bitcoin’s wild rise and fall. “Bitcoin’s foundation, its algorithms and network, don’t change with the exchange rate,” the pseudonymous site administrator writes. “It is just as important to the functioning of Silk Road at $1 as it is at $1,000. A rapidly changing price does have some effect, but it’s not as big as you might think.”

Silk Road’s customers, after all, aren’t generally interested in Bitcoin’s worth as an investment vehicle, so much as in how it makes it possible to privately buy heroin, cocaine, pills or marijuana. They use Bitcoin because it’s not issued or stored by banks and doesn’t require any online registrations, and thus offers a certain amount of anonymity. …

Silk Road has built-in protections against Bitcoin’s spikes and crashes. Although purchases on Silk Road can only be made with Bitcoin, sellers on the site have the option to peg their prices to the dollar, automatically adjusting them based on Bitcoin’s current exchange rate as defined by the central Bitcoin exchange Mt. Gox. To insulate those sellers against Bitcoin fluctuations, the eBay-like drug site also offers a hedging service. Sales are held in escrow until buyers receive their orders via mail, and vendors are given the choice to turn on a setting that pegs the escrow’s value to the dollar, with Silk Road itself covering any losses or taking any gains from Bitcoin’s swings in value that occur while the drugs are in transit. So while Bitcoin’s crash last week from $237 to less than $100 means that the Dread Pirate Roberts was likely forced to pay out much of the extra gains Silk Road made from Bitcoin’s rise, most of his sellers were protected from those price changes and continued to trade their drugs for Bitcoins despite the currency’s plummeting value.

What this shows is that Silk Road is separating the “unit of account” function of money from the “medium of exchange” function. Prices are denominated in dollars (as a unit of account) but payments are made in bitcoin (as a medium of exchange). Hedging is used to smooth out volatility.

Some folks still don’t grok the distinction. Here is CBS MoneyWatch getting it wrong in a story yesterday:

Well, if you did want to buy a house using Bitcoins as your medium of exchange, it would have been best to arrange for a closing no later than Wednesday morning. Because later that day, when the value of one Bitcoin reached an all-time high of $266 to a U.S. dollar, the digital money took a swan-dive. By late Wednesday, if you were still committed to the transaction, your house would have cost you twice as much – and even more if you had waited until the following day, because Bitcoins just kept losing value.

No. If you were using bitcoin merely as a medium of exchange your house would not have cost twice as much. What the reporter means is that it would have cost twice as much if you had used bitcoin as your unit of account for the mortgage, which would be a ridiculous thing to do. As Steve Hanke, quoted in the piece, says, “One of the functions of money is a unit of account for future payments, like a mortgage payment, so if you’ve got a lot of instability it’s a big problem.”

By the way, in that same article the reporter says I “backed off from the notion that [bitcoin] can serve as a stable store of value[.]” But I don’t see how I can back off from a view I’ve never held. Yes, there is this idea that bitcoin can be a stable store of value, it is an idea that excites many bitcoin enthusiasts, and it’s an idea I explain when I talk about bitcoin, but it’s not one I’ve ever held or promoted. Quite the opposite, I’ve written about how it’s not what makes Bitcoin interesting.

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