Excess Volatility as an Impediment for a Digital Currency

Abstract

Bitcoin is a digital currency and designed to have typical functions of a currency such as being a medium of exchange, a unit of account and a store of value. Each of these functions is adversely affected by the volatility of the currency. If a currency exhibits extreme fluctuations, its usage as a currency is limited, in particular if the currency is not backed by any government as is the case for Bitcoin. By means of an in-depth analysis of Bitcoin realized volatility, we show that the volatility of Bitcoin prices is extreme (up to 30 times larger) compared to major currencies (US dollar, the euro and the yen). The positive volume - volatility relationship further suggests that the majority of trading is noise trading. Our findings imply that Bitcoin cannot function as a currency.

Keywords: Bitcoin, digital currency, medium of exchange, realized volatility

JEL Classification: C58, E44, F31