Over the past four days, the price of Bitcoin, has fallen 22% from $385 to $300 against the US Dollar. There has not been any major negative events to cause this sharp drop. It's a simple case of supply and demand.

One opinion is that the influx of merchants accepting Bitcoin is causing the price to fall as they instantly sell any Bitcoin they receive. We discussed this effect in our article 'how will you spend your bitcoin?'. The BTC/USD price has fallen $287 or 48.9% since we last looked at it on August 10th.

The chart below shows the BTC/USD movement over the last 2 months

Bitcoin Supporters Remain Loyal

Supporters of Bitcoin, will tell you that this is not unusual. Bitcoin has always been extremely volatile. Some would argue that the drop in the BTC/USD price is an opportunity to buy. They are reacting in much the same way we'd react if our favourite brand of jeans were on sale.. put a few more in the closet.

This is an attitude which works for jeans, but could be dangerous when applied to investments. We all know the benefits of buying on sale, so let's look at the risks.

When you buy jeans on sale, you get ... an extra pair of jeans. This will increase your supply of jeans, so you may wear each pair less due to the dilution of their share of total jeans.

The worst that can happen... you bought them on an end of season sale. The next day the new look version is released and your new jeans look old and out of fashion right away. This risk is offset by the price reduction.

You could argue that the sale offered you fair value rather than a discount. You may not have jeans which meet the 'current look', but you didn't pay full price. So it may not have been a big saving, but it is still a good purchase

The BTC/USD price is a market price, Bitcoin is a traded investment on free markets. The price is not down because someone decided to 'put it on sale'. The price is down because Bitcoin sellers are outnumbering the buyers. Put simply: Money is flowing out of Bitcoin.

The faithful see it as a chance to 'buy more'. The logic being, that when the price goes back up, you'll be in a better position. If the price goes up, it is true, they will make a profit on the Bitcoin bought cheaply. This strategy comes with financial risk: What if the price doesn't go back up? Or worse yet, what if it keeps falling?

Buying more Bitcoin magnifies your profit if the price recovers, but also magnifies your losses if the price falls further. Unlike the jeans, you have overpaid for the Bitcoin as it has not yet found it's intrinsic value.

If you currently have $10,000 worth of Bitcoin (at a price of $300), and decide to buy an extra $2,000 worth, you now have 20% more Bitcoin. Your potential for gains is now magnified by 20%, but so is your potential for losses, as shown below:

Investments carry the risk of permanent and total loss. Any veteran of the 2000 tech wreck will tell you all the about the risks of buying more when prices are down. The faith they had in internet stocks is no different to the faith we are seeing in Bitcoin. Statements like 'it will reach $10,000 in 2 years time' or 'this is technology that will change the world', are reminiscent of the internet bubble.

We are not saying that Bitcoin will disappear into nothingness, but it is a very long way from causing any disruption to fiat currencies. Unless there is a significant change, it is hard to imagine the price recovering. If sellers continue to outnumber buyers, the price will continue to fall, it's as simple as that.

What do you think? Can the price recover, and if so, what will drive it upward?