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Dramatic Changes in Bitcoin Price Affect Liquidity

Yesterday was an extremely positive day for Bitcoin. Senator Tom Carper held a Senate Committee hearing to discuss the legal and business implications of Bitcoin’s ever-growing popularity.

Overall, the tone of the session was one of open-mindedness and desire to learn more about the digital currency. The representatives from FinCEN and the Attorney General explicitly stated that digital currency, in and of itself, is not illegal.

Related: Read our full summary of the Senate Committee hearing on Bitcoin

In response, Bitcoin’s price skyrocketed to over $900, a new all-time high. Bitcoin donned the front page of the Wall Street Journal this morning, was discussed on NPR, and made its way into every mainstream media outlet.

Then, the problems started. With increased interest and positive sentiment in Bitcoin came increased trading volume, and many trading platforms just could not handle the demand. And in response, the price of Bitcoin dropped back down to $500.

Liquidity Issues at Exchanges

Coinbase, a US-based startup, suddenly announced that it was hitting its normal buy limits and warned users that, while they could place orders, these orders would not be priced for up to 5 days. At Coinbase, investors cannot buy Bitcoin reliably. Note that Coinbase is not technically an exchange, but because of its ease-of-use and trustworthiness, many investors go to Coinbase to buy Bitcoin.

Mt.Gox, a Japan-based exchange, continues to have USD withdrawal liquidity issues. At Mt.Gox, investors cannot sell Bitcoin reliably.

Bitstamp, a Slovenia-based exchange, was hit with a DDOS (denial of service) attack this morning and went down just when the price dropped and investors wanted to buy.

Coinsetter, a relatively new trading platform, does not yet allow wire transfers from US customers and has trade minimums of 1 BTC.

Related: Coinsetter Launches US-Based Bitcoin Forex Trading Platform

These liquidity issues are a symptom of the reality that it is still early days for Bitcoin and demand is growing incredibly fast. But the problems these exchanges have experienced also highlight the risk in being a currency speculator in Bitcoin. You may be able to buy low or sell high, but perhaps not both on the same day.

Note: Other exchanges exist that were not profiled, namely BTC China (now the largest Bitcoin exchange in the world), BTC-e, and others. Read our comparison of exchanges and Bitcoin wallets to learn more.

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This question originally appeared on Quora, and was answered by Will O’Brien, owner of On Bitcoin.

Q: Which site is best for keeping a cloud bitcoin account? Specifically I want to: 1) keep my balance secure, and 2) change in and out of USD easily.

Sadly, the answer is none of them at this time. But there are some exciting new companies on the horizon.

First, some background. You can hold your Bitcoins in a wallet (cloud or desktop), at an exchange, or in cold storage. Each has its own profile for security and liquidity.

Security: There is a trade-off. Wallets and exchanges that are easier to use are often less secure. This is not a rule, just the current state of affairs. The biggest risk to Bitcoin is theft. If someone gets your private key, you will be robbed. See Bitcoin Theft: Mt. Gox Attack Pillages Investor’s Bitcoin Account as an example of how a Java chat applet was used to pillage a Mt.Gox user’s account.

Liquidity: Many exchanges have difficult account creation (to ensure security) and a prolonged wait to exchange to/from BTC, both as a hedge on currency volatility and because other institutions have delays, e.g., bank transfers. There is also regulatory risk and perceived regulatory risk. For example, Tradehill recently suspended its exchange due to regulatory concerns, Mt.Gox froze USD withdrawals, and Dwolla cut off Bitcoin users.

The general rules of thumb for both security and liquidity are:

1. Never keep a large amount of money in an single Bitcoin wallet. Some Bitcoiners would say a single wallet should be used only once and not hold more money than you would be comfortable losing in a theft.
2. If you are amassing BTC as an investment rather than day trading or buying and spending, consider cold storage.
3. Keep on top of your account security like you would at your bank. There will be new Bitcoin wallet services that do everything for you that BofA does today, but those are in the future, not the present.
4. Keep on top of your service provider. If they get impacted by regulation or attacks, so will you.

With that in mind, below are the major players to consider.

Coinbase - SF-based Bitcoin wallet startup
Pros:

• Probably the most user-friendly site available. It’s a simple, intuitive, web interface for buying and selling.
• Uses ACH transfer for buying/selling from USD.
• Real-time charts and exchange rates.
• VC-backed and reputable amongst the competition.
• Android app and iPhone app available.

Cons:

• Account setup is not trivial. Requires adding a bank account, verifying phone number, installing 2-factor authentication, etc.
• Transaction delays: BTC-to-BTC transactions take 1 hour to clear. BTC-to-USD and USD-to-BTC transaction take days.

Bitcoin Block Explorer – Blockchain.info - web and mobile Bitcoin wallet
Pros:

• iPhone app!
• You can buy BTC with SMS payments.

Cons:

• Very techie user interface, not intuitive.
• No services. Very basic buy/sell functionality.

Mt.Gox - Japan-based Bitcoin exchange
Pros:

• In the early days, Mt.Gox had a large amount of volume and liquidity.
• Still considered a leading exchange.

Cons:

• Instability: USD withdrawals were frozen (source: Mt. Gox Halts US Dollar Withdrawals at Bitcoin Exchange).
• Attacks: DDOS attack on Mt.Gox (source: Bitcoin Exchange Mt. Gox DDoS Attack: It’s Been an Epic Few Days).
• Regulatory risk and policy changes (source: Mt. Gox Forces Users to Verify Accounts After Government Crackdown).
• Account setup very challenging: need to upload scan of driver’s license or passport, and utility bill for proof of address. Then setup security center (Yubikeys or Software Authenticators). And more.
• Not based in US.

CampBX Bitcoin Trading Platform - US-based Bitcoin trading platform
Pros:

• Reviewed as better than Mt.Gox.
• Based in USA.

Cons:

• Delays in initial trading after placing funds.
• May be impacted by Dwolla decision to cut off Bitcoin exchanges.

BitGo - Startup with promise of most secure wallet (note: this is a relatively new startup with interesting technology that is coming to market soon)
Pros:

• Innovative security implementation enables most secure wallet.
• User-friendly site, easy to execute transactions.
• Best account creation flow.

Cons:

• New to market.

Companies no longer providing Bitcoin liquidity:

• Dwolla – online payment platform (source: Payment Network Dwolla Cuts Off Bitcoin Users)
• Tradehill – high-end trading platform (source: Bitcoin Exchange Tradehill Suspends Trading Due to Regulation Concerns)

Companies not profiled in this answer:

• BTC-e – Bulgarian cryptocurrency exchange
• CoinMkt – Relatively new exchange with thousands of trades
• OKPay.com – low-cost money transfers
• BitStamp – exchange based in Slovenia
• BitInstant – Winklevoss-backed startup Bitcoin exchange (site is currently down)
• Desktop Bitcoin wallets – e.g., Bitcoin-Qt, Armory, etc.
• In-person trading platforms – find somebody nearby to trade, e.g., LocalBitcoins.com, TradeBitcoin.com

CC image by by 401(K) 2013

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