Quote from: amwt on February 14, 2011, 06:18:09 PM

When a currency pool is too small to have any liquidity to determine effectively its value, I think currency pegging (to a major currency or a basket of currencies) is a more applicable modern concept than "backing" by any arbitrary precocious commodity.
http://en.wikipedia.org/wiki/Fixed_exchange_rate

In the case of BTC, this is all very academic. However, the above makes no sense.

"Precocious" commodity? Commodities cannot act, they are lumps of stuff. These lumps may have value to others in various ways, the value placed by those folks changing from moment to moment.

Who's precocious? That'd be the central bankers behind the issuance of all the major fiat currencies. They may or may not like how this market or that market is acting, and so step in with their heavy dull cudgel of open-market operations to lopsidedly inject more fiat currency into the marketplace, to the loss of all who are not first to get the new money.

Who are central-bankers to decide what the relative value of a thing is? Don't like how the market is acting? The market price is an emergent phenomenon arrived at by the sum total of free and open transactions done by the participants, who wanted to do those transactions at the time, or they would not have taken place.

So what you're really saying is that you don't trust the people who are participating in establishing a commodity's price by transacting in the market for that commodity. You would rather have an expert, the central planner at the central bank, observe and then by his fiat decide what is best for everyone.

As to liquidity, the market solves this (that is to say, in the market this is solved)^[1] by volatility. The only correct price is the one printed on the tape. And then only for that instant. If there are too few transactions taking place to keep this stable, then there is opportunity for speculators who believe for their own reasons that the price doesn't reflect the true value in the transaction. The more extreme the swing, the more speculation is attracted until there is enough transacting happening to dampen out the price oscillations.

Lack of liquidity/volatility could be a sign of uncertainty about conditions affecting the transaction, or a lack of interest in the thing being transacted. These are phenomena emergent out of the business actually taking place, and who are you to tell (via a peg) the market's participants what to do?

BTC's value has roughly tracked its popularity and notability. There was a very short spike toward $0.50 USD some time ago, when its popularity and notability were much lower. Lack of liquidity drove that. What happened? Speculators noticed. Most of them (as it happened) decided that the price on the tape couldn't possibly be efficiently reflecting the true worth of BTC at that time, and so just as quickly as it popped up due to lack of available BTC supply, supply soon rushed into the marketplace and cleared out the demand that created the spike.

The market is never wrong, because the market price is merely a report of instantaneous conditions.

^[1] Economists are wont to talk about the market as a thing unto itself, capable of its own actions and independent behaviors. This is a mistake. However, phrasing the market in that context is convenient shorthand when what you mean to discuss is really the summation of actions taken by the participants in a market.