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Why is bitcoin inherently volatile?
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@fiatjaf
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fiatjaf commented Feb 13, 2022

So the argument is that if Bitcoin is expected to constantly and predictably grow in value year over year, that this same growth will be arbitraged away and the price of Bitcoin will be today what it was supposed to be in 100 years?

How does volatility spring from that?

Maybe the argument is that traders would realize their arbitration was not very smart and then reverse the process in between?

Or is the argument one of necessity instead of a cause-and-effect description? Are you saying it has to be this way because otherwise the world would be broken but not attempting to explain the process by which things would be this way?

@fiatjaf
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fiatjaf commented Feb 13, 2022

Please consider this argument:

Bitcoin's fixed supply makes it so it is expected to grow in value in relation to all the other goods in the economy, right? But that is only true if we assume the economy will grow, i.e. there will be more goods or better goods produced in total as the time passes. If the quantity of goods stayed the same each bitcoin would still buy the same amount of goods, and if the quantity of goods diminished each bitcoin would then buy less goods.

If the above is true, then holding Bitcoin wouldn't be a risk free activity, it would be a bet on the overall increase in productivity. A bet that cannot be arbitraged away.

@fernandonm
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fernandonm commented Feb 13, 2022

Once we discount marginal holding costs, nothing can "predictably grow in value", otherwise it would be stupid not to hoard more or it (intertemporal arbitrage). At the margin, returns equate holding costs.

Volatility is a holding cost, derived from the uncertainty/risk about the future value of an asset. The riskier an investment, the less people will be willing to hold it, and the greater the expected return they will require. Similarly, most people is willing to pay significant insurance premiums to reduce risks. I.e. you wouldn't play lottery with the money you need to pay rent, even if it had a positive expected return.

Bitcoin's deterministic supply implies that any changes in its demand expectations imply price fluctuations. Not only if demand grows, which I used in the article to illustrate the impossibility of having positive returns with certainty. The price of bitcoin can only stabilize if the expectations about its future demand remained stationary. But the future is always uncertain.

I believe bitcoin is a bet on r being depressed below g by government intervention and other risks derived from trust requirements. This is a utility with a fluctuating and uncertain magnitude. Increases in productivity are uncertain themselves, as you can observe in the volatility of broad stock indexes.

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