Why Is Bitcoin So Volatile?

A Bitcoin superhero surfing on a giant wave of price volatility, with dollar signs and Bitcoin symbols crashing around. in comic style
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Why Is Bitcoin So Volatile?

Bitcoin is the first and most well-known cryptocurrency that has captured the public’s imagination since its creation in 2009. However, one aspect of Bitcoin that gives some investors pause is its volatile price history.

What Causes Bitcoin’s Price Volatility?

While most financial assets experience price fluctuations, Bitcoin’s swings can be dramatic. There are several key factors that contribute to Bitcoin’s notorious volatility.

Limited Supply

One of the main drivers of Bitcoin’s price is its limited supply. Satoshi Nakamoto, Bitcoin’s enigmatic founder, capped the total number of Bitcoins that could ever be mined at 21 million.

With over 19 million Bitcoins already in circulation, the remaining supply is dwindling. This scarcity creates more competition among investors to get their hands on what little Bitcoin is left. As demand increases against limited supply, Bitcoin’s price gets bid up.

Investor Psychology

As an emerging asset, Bitcoin is still establishing its value. With no underlying fundamentals like a company’s earnings to anchor its price, Bitcoin ends up being highly sentiment driven. Investor emotions like fear and greed can trigger irrational market moves.

When Bitcoin’s price is rising quickly, this attracts speculative money looking to profit from momentum trading. But these investors are fickle and will rush for the exits at any sign of a downturn. This herd mentality exaggerates Bitcoin’s volatility in both directions.

Whales Influence

A small number of major investors dubbed „Bitcoin whales“ control a significant portion of Bitcoin’s total supply. It’s estimated that just 2% of anonymous accounts control 95% of all Bitcoin.

If one of these whales decides to take profits or cut their losses on a position, it can have an outsized effect on Bitcoin’s price due to the large transaction sizes involved. The whales often set the price direction that the rest of the market follows.

The Impact of Whales on Crypto Exchanges

The outsized influence that Bitcoin whales have on prices can extend to cryptocurrency exchanges as well. Exchanges like Coinbase, Binance, Kraken, and Bitcoin Union rely heavily on the trading volumes and liquidity provided by these whales.

For example, if a whale decides to cash out a large Bitcoin position on an exchange, it can flood the market with sell orders. This spike in sell-side activity can trigger cascading selling from algorithmic traders and liquidations of leveraged positions.

The result can be a sharp Bitcoin price drop across exchanges in a short timeframe. Conversely, a large whale purchase can rapidly propel Bitcoin higher.

Crypto exchanges have to factor in the price volatility that whales can induce and ensure they have adequate liquidity to handle huge trade sizes. Exchanges also try to attract major whales to trade on their platforms and provide liquidity by offering lower trading fees, over-the-counter desks, and preferential services.

By competing for whale business, cryptocurrency exchanges can bolster their trading volumes, liquidity, and ultimately their own revenues and valuations. Thus the outsized influence of Bitcoin whales extends into the business models of major crypto exchanges as well. Managing the volatility from whales is crucial for exchanges to operate smoothly.

Media Hype

The mainstream media loves to run sensational Bitcoin stories because they attract eyeballs. But the breathless news coverage tends to be light on facts and proper context.

For example, when El Salvador announced it would accept Bitcoin as legal tender in 2021, the media widely covered it as a revolutionary adoption. In reality, Bitcoin has had minimal utility in El Salvador. The hype pumped up Bitcoin’s price, until it eventually deflated.

This dynamic where the media amplifies Bitcoin speculation helps drive volatility spikes.

Regulatory Uncertainty

Government policies around cryptocurrency are still evolving. Sudden regulatory crackdowns, like China’s 2021 Bitcoin mining ban, have put immediate pressure on Bitcoin’s price.

Conversely, positive developments like the approval of a Bitcoin ETF in late 2021 prompted a price surge. Bitcoin volatility surges around these regulatory event risks, which are often hard to predict.

How Does Bitcoin Volatility Compare to Other Assets?

To put Bitcoin’s volatility in perspective, it helps to compare it to other financial assets:

  • Bitcoin’s average 30-day volatility is 75% higher than gold and 5 times more volatile than the S&P 500 stocks index.
  • Bitcoin is 3 times more volatile than the Russian ruble currency but slightly less volatile than the Turkish lira.
  • Meme stocks like GameStop and AMC have 2-3 times higher volatility than Bitcoin over short time horizons.

So Bitcoin is clearly among the most volatile liquid assets in financial markets. Nevertheless, its volatility has been declining over time as the market matures.

What’s Behind Bitcoin’s Mega Price Swings?

While Bitcoin is always moving, some of its biggest historical price moves stemmed from specific events. Here are some examples:

March 2017: Price Doubles After SEC Decision

After rejecting a Bitcoin ETF proposal, the SEC indicated Bitcoin was subject to federal securities laws. This was seen as legitimizing Bitcoin. Bitcoin’s price surged from $1,200 to over $2,400 within two months.

December 2017: Bubble Bursts After Launch of Futures

Bitcoin mania reached its peak when Bitcoin futures launched, opening the cryptocurrency to mainstream speculation. The resulting bubble popped soon after, sending Bitcoin down over 60% by early 2018.

March 2020: Black Thursday Crash

On March 12, 2020 Bitcoin lost over 50% of its value in a single day, plunging from nearly $8,000 down below $4,000. A liquidity crisis hit the cryptocurrency exchanges as the COVID pandemic roiled financial markets worldwide.

May 2021: Elon Musk Flip-flop

Tesla CEO Elon Musk announced Tesla would no longer accept Bitcoin payments due to environmental concerns in May 2021. This reversed his earlier support and led to a price drop from $57,000 to below $49,000.

November 2021: All-Time High After ETF Launches

The launch of the first U.S. Bitcoin futures ETF sent Bitcoin soaring to an all-time high above $68,000 in November 2021. It gained over 40% in just a few weeks as investors piled into the ETF.

As these examples demonstrate, major news events tied to regulation, adoption, or market structure changes have been behind Bitcoin’s largest price moves historically.

Factors That Could Stabilize Bitcoin

While past performance shows Bitcoin’s price is volatile, certain developments could help stabilize it:

Increased Institutional Adoption

Growing investment in Bitcoin by banks, mutual funds, and other mainstream financial players could dampen volatility by improving liquidity and market depth.

Bitcoin Futures Market Growth

As Bitcoin futures and options markets mature, they will help discover fair value prices while providing hedging tools to manage risk. This could smooth out some volatility.

Improved Custody and Investment Products

Securities like Bitcoin ETFs and developments in cold storage could make Bitcoin investing easier for the typical investor. Broader access for retail investors can stabilize prices.

Higher Bitcoin Market Capitalization

With a market cap nearing $1 trillion, Bitcoin is the largest cryptocurrency but still tiny compared to stocks and forex markets. As the market cap grows, Bitcoin will be less susceptible to large price swings.

Can Bitcoin Become a Stable Currency?

While it’s possible Bitcoin volatility could decline as the cryptocurrency matures, it is unlikely to ever become a truly stable currency. However, lower volatility could make it more usable as a payment method or store of value.

It is difficult to see Bitcoin rivaling the price stability of reserve currencies like the U.S. dollar without having a central bank managing monetary policy around it. Nations need stable currencies to carry out trade and commerce.

Nevertheless, Bitcoin’s bounded supply and decentralized nature means it could provide an inflation hedge. Investors may treat Bitcoin more like digital gold than digital cash in the future – a hard asset for hedging inflation risks.

Taming the Beast: How to Manage Bitcoin Volatility Risks

For investors interested in holding Bitcoin, strategies can help manage the volatility:

  • Dollar-cost average – Buy Bitcoin at regular intervals over time to smooth out price exposure
  • Asset allocate – Only invest 1-5% of your portfolio in Bitcoin to limit risk
  • Hedge – Use Bitcoin futures or options to protect against price declines
  • Hold long-term – Bitcoin’s volatility declines over longer horizons of 3-5 years

Volatility creates risks but also opportunities. Savvy investors can use Bitcoin’s price swings to their advantage.

Frequently Asked Questions About Bitcoin Volatility

Here are answers to some common questions about Bitcoin’s price volatility:

What causes Bitcoin to be so volatile compared to stocks and forex markets?

Bitcoin lacks the scale and mainstream adoption of larger markets. With its limited supply and speculative investor base, any minor event can trigger outsized moves. News and rumors easily sway Bitcoin’s thinly traded market.

How long will Bitcoin’s volatility last?

It could take 5-10 more years for Bitcoin volatility to moderate. Bitcoin needs larger scale institutional adoption, sophisticated derivatives markets, and broader retail penetration before volatility significantly declines.

Can Bitcoin’s price go to zero?

Zero is unlikely unless a major flaw is found in Bitcoin’s cryptography or network security. As a decentralized system, Bitcoin cannot simply be shut down by any entity. Network effects also make extinction improbable at this point.

What events tend to cause the largest price swings?

Regulatory decisions, technical developments like the launch of futures trading, and statements from influential business leaders have historically moved Bitcoin’s price the most.

Why does Bitcoin have bigger price swings than stocks?

Stocks represent shares in real companies with assets. Bitcoin has no underlying fundamentals beyond speculative demand. This makes it more susceptible to boom and bust cycles.

How high could Bitcoin’s price rise in the future?

Bitcoin could reach $100,000 to $500,000 per coin in the next decade if it becomes a digital gold investment and institutional adoption continues rising exponentially.

Will Bitcoin’s price ever stabilize?

Bitcoin will likely remain volatile compared to the dollar, but increased maturity could dampen its volatility enough for broader utility to develop beyond just speculative trading.

Should I invest in Bitcoin despite the volatility?

For investors able to stomach the risks, Bitcoin’s volatility creates potential profit opportunities. But limit any allocation to a few percent of your portfolio for appropriate risk management.

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