Measuring Bitcoin Speculation


I’m not normally one to delve too deeply into the world of financial charts, math and indices – oh I can read all variety of charts just fine and make arbitrary speculative guesses with the best of them, but I’ve seldom considered myself clever enough to make any attempt at inventing my own. The standard investment data has been around for ages, after all, and many were thought up by Nobel laureates so what kind of hubris would I need to even make an attempt? I recently had a realization that changes that viewpoint: None of those Nobel laureates had the kind of perfect and transparent view of a market that Bitcoin provides so maybe my observations, no matter how obvious they seem, weren’t implemented because the data wasn’t available, rather than because they’re silly or wrong…

In a recent post, I mused that the primary driver of Bitcoin’s value is the network effect – the more people and businesses we have participating in this thing, the more utility it represents and therefore the higher its inherent value. There’s another thing that can raise Bitcoin’s value, though, and it’s not a good thing: speculation. Now speculation in small doses is fine, we all do a bit of it here and there, it can be fun and profitable and indeed active exchanges and folks to arbitrage between them are important parts of any market – too much speculation, however, and you get what we had last summer.

For those of you who weren’t around or somehow missed the memo, in June of 2011 Bitcoin experienced a massive economic bubble. Rampant speculation combined with reckless optimism ratcheted up the price of a bitcoin to just over $30 USD before the bubble finally popped and the price drifted back down and remained stable around $5 for quite some time. Today, one bitcoin will cost you around $11 USD, more than double that stable post-bubble price point. The run up to $11 has been much slower and stabler than the run to $31 but that’s no guarantee at all since most economic bubbles happen much slower than the one we saw last summer. How can we even attempt to measure whether a change in value is genuine or not?

Well, Bitcoin is trying to be a currency, right? So let’s look at what a healthy currency market looks like. If I look at how the average U.S. Dollar gets spent, I can see that some fraction of them are flying around exchanges being traded for other currencies but I can also see that the vast majority of the dollars that move in a given day are being spent by people, moving around the everyday economy that we all participate in. In other words, the ratio of transaction dollars to trade dollars is quite high.

It’s also important to note that looking at one piece of data without the other would be a bad idea. Speculators have to move bitcoins around too, between exchanges for arbitrage or across wallets or services to get into or out of the market – all mundane-looking transactions that we’ve got no way of filtering out. So let’s stick to that first idea and look at the ratio. Bitcoin, unlike any other currency that’s ever existed, is uniquely able to provide every last snippet of data we need at whatever resolution we’d like. One Python script and a API later I had comma-separated data ready for Excel-powered analysis.

Above is a chart showing Bitcoin price in U.S. Dollars (blue) and transaction volume divided by trade volume (red). Sadly, the span of time I’m most interested in – the very beginning of the speculative bubble – is a pit of useless data. With daily transaction and trade volumes often under $1,000 USD the ratios were little more than random data. One person spending $100 on an exchange could completely destroy the ratios. I also noted there were a couple of large spikes in transaction volume that, to my knowledge, have never been explained fully but are mostly due to the movements of a single large balance across multiple accounts. Ignoring the early noise and obvious outliers, some useful data finally emerges.

Little more than a glance shows that the tx/trade ratio sat stagnant through the entire bubble – the Bitcoin economy, at least the non-speculative bits of it, didn’t appear to grow at all. Equally interesting, the long slow run-up to $11 we’ve seen in recent days has in fact been accompanied by a slow and steady increase of that same ratio, suggesting that the non-speculative economy has actually grown at a commensurate pace with price and that the current price may well be perfectly reasonable.

So is this simple piece of math, which I’ve decided to call the “Speculation Index” the magical predictor we’ve all been waiting for? Hardly. I think it provides some useful data that we were not only missing before, but which may not even be possible to calculate in any traditional currency market – and that data is certainly worth a glance. Thus far there seems to be a clear pattern emerging from the data, but it could just as easily be that I’ve stumbled upon an arbitrary calculation that fits historical data nicely and is meaningless moving forward. Only time will tell.

Update: Ben over at was kind enough to add a chart that shows the above data, updates automatically and has all the options that’s other charts have. Thanks, Ben!

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  1. Speculation comes with the territory. People speculate bitcoin will be worth much more in the future because they have a lot of faith in the currency. If nobody had any faith in the currency, they would speculate it would be worth a lot less, and prices would reflect that.

    I think the major problem facing bitcoin a year ago was its lack of liquidity. But as things like BitInstant and CoinBase come online the liquidity issue will no longer be a problem, and a plunge in price is a lot less likely to happen, unless tons of people suddenly lose faith in the currency.

    • True, the concept here is that we're always asking if the fundamentals have changed or if any given thing we're looking at is just another speculative bubble – and adoption/use as a currency rather than an investment vehicle is one of the fundamentals I'm trying to measure.

      A high ratio of tx to transaction volume would indicate actual adoption where a low ratio would indicate primarily speculation, which could perhaps be a meaningful indicator when coupled with other data.

  2. The problem from last summer was not that "lots of speculation" was going on. Rather, the problem was that the speculation was wildly wrong. Part of the reason for this is that there was no way to speculate downward, only upward. Remember that speculation is two-sided – if there's "lots of speculation" but the bulls and bears are roughly even, then you have a very stable market. If all the speculation is bullish in part because there's no good way to speculate downward, then stability is wiped out.

    The more speculation, the better. The caveat is that tools need to be available for speculating in all directions. Last summer that didn't exist. Today it does. The change happened when Bitcoinica launched with the first way to short Bitcoin. While Bitcoinica is gone, other shorting methods have developed, even advanced tools like options and leverage.

    We should be encouraging speculation…and if people are speculating two much in one direction, we ought to speculate in the other :) It is not from lack of speculation that markets stabilize, but from myriad speculation.

    • But we're not talking about a general market with a product you can evaluate the fundamentals of in normal ways, we're talking about Bitcoin. While the same sort of rules apply on the speculative side as any other market, the "product" behind a "share" of Bitcoin has value based on adoption and usage numbers – the network effect. It's hard to say whether the speculation is "right" or not when the speculation itself makes it hard to measure that underlying value.

      My hope with this isn't to stop speculation but to find a set of tools to look at a price change and answer the question "is this a genuine change based on the fundamentals of the 'product' or is this a market fluctuation?"

      Speculative bubbles like we saw last summer happen when a self-reinforcing cycle takes hold of the market and drives prices up until they're no longer sustainable. If more investors have tools to tell the difference between a genuine value rise and the start of a bubble, those self-reinforcing cycles will have a harder time taking hold. Assuming my findings hold into the future, which they may not, this is potentially a tool for telling the difference.

    • Excellent post. I absolutely agree. I am interested to know where we can go short or acquire options – (puts and calls) at this time. Maybe someone out there knows ?

  3. limitcycle says:

    this post and chart is especially relevant at the moment. The ratio of trade to transaction has been in decline since mid January. Both are up but the trade has gone more than parabolic.

  4. JasonD says:

    The more you speculate, the more the market moves in the opposite direction of speculation. That is a fact that fuels every chart. Majority looses, every time. Thus, majority "speculation", is always wrong. If it was ever right, then the majority would be winners, and the chart would still move in the opposite direction, as value decreases from the majority having "won", and being "willing to sell for less".

  5. The chart at blockchain info shows the reverse of your chart – it shows trade to transaction volume and is alway > 1. So is there more speculation going on then transactions?


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