Purchasing Power Parity of Bitcoin compared to the Dollar - Part one

In the last months of 2015 the price of Bitcoin has dropped from $330 to $150 and at the time of this explanation was hovering around $230. At the same time the Dollar was gaining strength among fiat currencies. These two stories together made a lot of people doubt the viability of Bitcoin as a safe investment as it seems that Bitcoin was bearish when both the Dollar and Gold are bullish.

However this conclusion is an illusion caused by the fact that we have loosely “pegged” Bitcoin to the US Dollar in that we measure its strength in terms of dollar purchasing power. Now here starts the catch 22, how do we measure the dollar's strength? We compare it to the purchasing power of other fiat currencies, while none of them are pegged in real life.

This scenario causes skewed interpretations as Bitcoin will appear bullish in one nation as opposed to bearish in another, depending on how the local fiat currency is doing. This can be illustrated in the below graph which shows Bitcoin prices as in USD and Russian Ruble.

Another thing to recognize is that our current economy relies on steady and constant inflation. This effectively means that your dollar can purchase less over time as there is an influx of new banknotes, due to supply and demand. This scenario also causes a steady but false increase in Bitcoins value, while its real life purchasing power remains the same.

For simple proof of the concept above, ask any American how far they could get with 5,000 dollars before 1971 or study the following graph illustrating the purchasing power of the dollar since 1967 (I will go into this data in more detail in my next post).

As illustrated in the above scenarios, then our current measurement system for Bitcoins value is broken as it relies on fiat currencies to determine its relative purchasing power. I suggest that we start “pegging” the measurement tool of Bitcoin value to purchasing power of gold.

My reasoning for this, is that gold prices auto correct for fiat volatility almost instantly, as gold has a universal value.

Gold prices constantly vary, however, I argue that this is due to the above phenomenon of inflation, causing the purchasing power of the dollar to decrease. This artificially drives up the price of gold while the purchasing power of gold has remained more or less constant. This is of course difficult to prove as not a lot of merchants accept gold as a payment and there are no official reports of the purchasing power of gold.

There is also the fact that only a few gold merchants at present accept Bitcoin, and thus to find the true gold purchasing power of Bitcoin, we usually have to convert the bitcoin back into your fiat currency of choice.

However, if we did use gold purchasing power as the standard for measuring the strength of Bitcoin. Then we would also have a universal indicator, which needs no conversion between borders, and shows the true strength of Bitcoin.

I will delve more into this in our next piece.