The price of Bitcoin, the anonymous peer-to-peer digital currency, plummeted after the alleged founder of the online drugs marketplace Silk Road was arrested in San Francisco.
On Wednesday afternoon the price of one Bitcoin (BTC) was $145.70 on Mt Gox, one of the largest exchanges for the currency.
After the news that Ross Ulbricht had been arrested and the Silk Road site seized, the exchange rate plummeted to a low of $109.76, before recovering to $124.00 late on Thursday.
Bitcoin's record high was $266
In the history of the notoriously volatile currency, Wednesday’s fluctuations are minor. Bitcoin has experienced two major booms and busts, one in 2011 when the value of one Bitcoin went from $2 to $30 and back in little more than six months, and another earlier this year, when the price shot from $13 to a high of $266, before dropping back to a low of $50.
Even on a slow trading period, Bitcoin remains extremely volatile. It is not uncommon to see the currency gain or lose 6% or 7% of its value over the course of a day with no obvious news event driving the change. The average daily change of the S&P 500 is a tenth of that.
Bitcoin and Silk Road are closely linked. The site, which enables users to anonymously order drugs, guns, and more through the postal service, only takes payments in the digital currency. In doing so, it makes it significantly harder for authorities to follow the money to discover the real identities of buyers and sellers.
The technology behind Bitcoin is similar to public-key encryption,the algorithm behind most internet security. Users have a 'wallet', which is a public address that can send and receive Bitcoins, and a private key with which they can access the wallet. So long as the link between a particular wallet and a user is not made public, the currency can remain fully anonymous.
But if a Bitcoin wallet becomes associated with a particular person, some of the security benefits disappear. Because transactions between wallets are public,it can then become possible to trace transactions.
“Obviously the major price drop we saw yesterday was people scrabbling for the exit,” says Jeremy Cook, chief economist at currency brokers World First, who describes Bitcoin as “intrinsically linked” to Silk Road. “You've bought Bitcoin as an investment, or you've bought it as a transactional medium. If it’s one, you’ve just seen a major marketplace shut down, and if it’s the other, the value has dropped suddenly. You will sell it.”
Price drop 'motivated by fear'
Emily Spaven, editor of the digital currency news websiteCoinDesk, agrees that fear is motivating the drop in price. “The price of Bitcoin has fallen since the closure of Silk Road, not because the website was the lynchpin of the Bitcoin ecosystem, but because some people are fearful that this is the beginning of the end.”
Silk Road remained one of the most prominent large-scale operations that used Bitcoin, and the largest to exclusively require the use of the currency. While a number of establishments announced they would be accepting payments in Bitcoin, includinga pub in Hackney, east London, many customers appeared to be making the most of the novelty value only.
As a result, the site seemed to provide a significant share of actual use of Bitcoin. Even so,one paper from 2012(pdf) pegged the site as making up just 4.5% of the entire Bitcoin economy. Informationfrom the FBI’s criminal complaintsuggests that the average daily volume of Silk Road trades is 10,000 BTC, again around 5% of the 200,000 BTC thatthe site blockchain.infosays is the low end of daily transactions in Bitcoin.
Bitcoin 'not reliant on Silk Road'
“The reality is, Silk Road doesn't play any part in a high proportion of Bitcoin users' lives,” says Spaven. “The Bitcoin economy certainly isn’t reliant on Silk Road; there are hundreds of other websites that accept Bitcoins and I'm confident the list of these will continue to grow.”
Indeed, Spaven raises the possibility that the Silk Road bust could be a good thing for the currency. “If anything, the fall of Silk Road has done Bitcoin a favour. Hopefully now that the website no longer exists, people will start to see Bitcoin in a more positive light and appreciate the numerous benefits it offers.” The Reuters blogger Felix Salmon agrees, suggesting that until now, the fear of such a bust may have exerted a downward pressure on prices. “With Silk Road gone, a significant source of downside tail risk has now been effectively removed from the Bitcoinverse,”he writes.
The other question for the currency is what effectthe FBI’s seizure of 26,000 Bitcoins, worth around $3.25m at current prices, will have on its economy. If the bureau decides to auction off the seized assets, the glut in supply could temporarily depress prices, and the removal of such a large number from circulation is in effect a monetary tightening. But Cook points out that the quantity is still tiny compared to the total number of Bitcoins available, thought to be almost 12m. “In the grand scheme of things, it's not too much of a liquidity shock.”
