The correlation between MtGox/USD [1] and GLD daily returns over 12 April 2011 - 30 March 2012 is 0.02; a linear regression produces a 0.151 beta (GLD daily returns independent) with a coefficient of determination of 0.0004. GLD had a period return of 14% with an average daily return (standard deviation) of 1.4% (0.1 percentage points); MtGox/USD had 531% with 10.2% (1.3 percentage points). It thus seems like it could have a place in a portfolio above (in terms of risk) small cap and emerging market stocks (on your worst day in GLD you lost 5.5%; in MtGox/USD 35.8%. Also, GLD delivered 2.7 times the return per unit of risk). Methodology note: since MtGox trades every day and GLD only on trading days, I used closing prices for trading days.
Bitcoin takes the monetary system back essentially a hundred years. We know how to beat that system. In fact, we know how to nuke it for profit. Bitcoin is volatile, inherently deflationary and has no lender of last resort. Cornering and squeezing would work well - they use mass in a finite trading space. Modern predatory algos like bandsaw (testing markets by raising and suddenly dropping prices), sharktooth (electronically front-running orders), and band-burst (creating self-perpetuating volatile equilibria in a leverage-sensitive trading space, e.g. an inherently deflationary one), would rapidly wreak havoc. There is also a part of me that figures regulators will turn a blind eye to Bitcoin shenanigans.
[1] http://bitcoincharts.com/charts/mtgoxUSD#rg60ztgSzm1g10zm2g2...
1) If you know how to nuke the bitcoin system for profit, are you doing so? It's not clear to me that you personally would be able to corner and squeeze as easily as you think, because I believe most bitcoins are held by a small group of people with a long term interest in a viable bitcoin economy.
2) HFT is usually justified by its practitioners as improving the stability and liquidity of the market, but here you characterize it as a fundamentally predatory tool if applied to bitcoin. What do you think about it in general?
That actually makes the actions of a serious predatory trader even more dangerous, since the total pool of available bitcoins is smaller due to the number of people just sitting on their bitcoins. In fact, it could be worse, especially if the trader causes the market to drop, which could make the investors bail out of the market, lowering the price of bitcoins even further. The trader then buys up the bitcoins for a song and a dance.
Now, if people weren't hoarding bitcoins, it would be much less of a problem. If the majority of the currency was liquid and actually flowing, it's much harder to corner the market on it.
Re: 2:
This isn't necessarily HFT-specific. HFT is constrained by a lot of rules-both regulatory and exchange-specific-that attempt to stop this kind of damage(for example, NASDAQ has the right to void any trade chain that takes place if they deem it necessary), as well as a massive amount of competition from other players in the market. With Bitcoins, there aren't any of these rules, either on the exchange level or regulatory. There is not anything to stop a trader, either using HFT algorithms or just manually executing the trades, from applying these techniques.
A currency's value isn't a function of how much of it is outstanding but how much is transacted in it. If "most bitcoins are held by...people" holding on speculation, they contribute to holding its value down (don't think of stocks with dividends, think of fx). They also make the market smaller and less liquid.
2) The quote cycling HF market making algos use to discover prices disappears in a liquid market. If done in penny stocks, on the other hand, it would scare the hell out of everyone when a market order executes against a discovery bid way out on Pluto.
When these slips happen the HF guys get hurt - that's why they pull their servers causing the liquidity cuts they're criticised for. Thus, they work to predict when that kind of slip-up will happen. I'm reversing the logic and saying I'll force the slip-up and take advantage of the volatility right after, something with uncertain pay-off in liquid markets (you burn yourself in spawning the unstable equilibria) but more definite pay-off in illiquid ones.
Note that I wouldn't recommend trading Bitcoins at a high frequency for the same reason that HFs don't mess with penny stocks. The pay-off is too low compared with the infrastructure investment required. I'd probably also blow my cover with the exchanges.
Hope that answers your question!
[1] http://opinionator.blogs.nytimes.com/2011/03/02/a-conspiracy...
[2] http://www.lextechnologiae.com/2011/06/26/why-bitcoin-isnt-a...
wouldn't it be difficult to cause such HFT havoc on a currency that is not that frequently traded (relative to big exchanges)? After all, someone has to be on the other side of all those HF trades. Also, since it's heavily decentralized wouldn't that make it more difficult to execute trades in high quantities?
How do you "corner and squeeze" a market that can't be shorted? You can manipulate GLD down by issuing naked shorts (essentially counterfeited against collateral). But you can't counterfeit Bitcoin. If you want to drop the market price of Bitcoin, you have to sell actual BC that you had before and don't have now.
Then, to actually profit, you have to find a way to buy those BC back for less than you sold for. This isn't going to happen unless your smart algo finds an equal and opposite stupid algo that it can rape. Who gets raped and why?
(If you ask me, it's BC that's a well-designed market and Wall Street that's a funky, broken anachronism. A lot of stupid pointless volatility would go away if we eliminated synthetic securities and lenders of last resort, and replaced the ancient order-matching system with a central limit-order book. Then, you'd have to actually add information to the system in order to profit - rather than profiting by raping other algos, and more plausibly retail traders, with "sharktooth and band-burst.")
let's move on to something else
As for the economic critiques, of course bitcoins are no panacea. These critiques are relevant to any market; the punchline of the article was even "I'd say the same about the Euro"
Unfortunately, Bitcoin is not "men with guns entering your house or server location and taking your drive" proof.
http://www.forbes.com/sites/jonmatonis/2012/03/12/brainwalle...
At this point, Bitcoin is being treated as a speculative instrument. It does not share the same status as gold, being a store of value, and thus it will not move based on the fears and hopes of fiat currencies. From that standpoint, it should be entirely uncorrelated from the fiat banking system and traditional investments. Be careful if you are trading for Bitcoins denominated non-USD, as those prices will move with exchange rates as well.
From a regulatory standpoint, Bitcoin is in limbo. Right now, it's no different than trading bottle caps, but when the regulators come down on it, there will be a different story.
In short, the two forms of investment risk you face are volatility price risk and regulatory risk.
Also, consider that over 80% of the foreign exchange market is accounted by 6 currencies or so: US dollar, yen, euro, British pound, Swiss franc and Australian dollar. Traders barely bother with the Brazilian real or Indian rupee, even though these currencies are much more likely than bitcoin to be around in 5 years.
How so? As bitcoin is a p2p network, it is likely to be around whatever happens. The only thing that could happen would be that internet breaks down - pretty unlikely, I think. Even when internet breaks in several pieces, each "local internet" will just use their own bitcoin - the block chain will be split in to several. After the two "local internets merge", the blockchain which has more computation behind it, will win.
In discussion, you should separate two things a) bitcoin's economic value/utility b) bitcoin network itself. I'm pretty sure that bitcoin itself will be here about forever, however it is pretty unclear if anyone will use it.
Or maybe people would simply lose their interest in to bitcoins, or start using something else. Maybe Google will invent their own bitcoin, and everyone starts using that. Or maybe something else happens.
When the USG starts shutting down the exchanges, which will happen any minute now, Bitcoin will go to zero and stay there. Everyone who thought their BTC was worth USG will want out - and find that the doors are now locked. The BTC price won't even be epsilon. It'll be zero.
The monetary design of Bitcoin is sound. The political design, not so.
The USG has been successful killing payment companies before (eg e-gold, epassporte, neteller), but those were of course centralized systems. Bitcoin is decentralized, which is why its supporters believe that it is here to stay regardless of the actions of any particular government.
The US dollar is a centralized system. US financial regulation is in effect worldwide (except now Iran, I guess). If you have a decentralized system dependent on a centralized one, it's a centralized system.
Bitcoin is not dependent on the USD for its operations, just for its value. The day after MtGox (for instance) is indicted, everyone will be selling and no one will be buying. Also, all payment processors everywhere will cut off all Bitcoin exchanges everywhere.
(Everywhere excluding Iran, I guess. Is Bitcoin big in Iran?)
But what about your neighbor Bob's place? You buy him dinner, and the next day a string of bits comes your way via Tor (or somesuch.) There is no need to utter the word "Bitcoin" during said dinner. A wink, a nudge, etc. will suffice. The next day, Bob does the same with his neighbor Charlie. And so on.
And, naturally, if Bob were a traitor, he could rat you out to the Gestapo. But he could just as easily rat you out for [insert extremely popular but highly-illegal-in-the-USA activity here.] No digital cocaine required - the analog kind will do. And if you haven't any under your bed, Bob will helpfully leave a kilo in your toilet tank.
Most people have already had plenty of practice exchanging highly-illegal strings of bits. Now they will just need to learn to give each other "free" stuff as well.
Bitcoin hasn't reached the critical mass needed for this kind of thing, but there is no reason why it could not.
Consider hawala (http://en.wikipedia.org/wiki/Hawala) which is doing quite well despite draconian bans. On which currencies do hawala transactions depend? All of them and none of them.
I wouldn't say 'big' exactly, but the participation is non-zero: http://blockchain.info/nodes-globe?series=48hrs