Ripple Effect and Price irrationality of Bitcoin

*Irrationality in prices

Behavioral economists have tried to correlate and predict price movements in markets with behaviors of traders. Since most such analyzed markets were in stable economies that were efficient and usually upheld the rule of law, irrationality was quickly absorbed by markets. Irrational exuberance, as in the times of the dot-com boom quickly devolved and disappeared. All this was good, as long as the markets were local (geographically) and as long as traders were local firms that were under the purview of the law of the land.

*With Bitcoin, things have changed.

With a 24X7 market and a globally available(distributable) asset, these behavioral inconsistencies can potentially last for a long long time. Off late, this irrationality and exuberance have meant arbitrage opportunities for other asset classes in nations where political and economic instability have taken place.

Such instability has had a tremendous spillover effect on the price of Bitcoin. Over the past 3 days, since the regime was toppled in Zimbabwe, citizens have – attempted to move their assets into Bitcoin. Exchanges for the local currency saw brisk trades giving it a rise of over 200%.

*Ripple Effect

However, these prices are mostly local and do not spiral out to global markets, on account of low demand for such expensive assets. For example, the markets in Zimbabwe have had less than monthly transaction volume of USD 1 Million. Compare this with an average daily transaction volume of greater than 1.4 Billion USD for Bitcoin globally.

This clearly shows that though local markets can, at times, in the face of sudden economic uncertainty exhibit irrationality in prices; global markets will not be affected unless volumes are large.

You can consider this as similar to a ripple effect on a large pond of water. Unless and until the stone thrown into the pond is large enough the ripples will not reach the edge of the pond. In Physics and Economics, this is modeled as a Ripple Effect.

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