We can describe volatility as how much the value of an asset changes over a given time. A volatility index usually measures volatility. However, there is not yet a generally accepted index for Bitcoin because, as an asset class, it’s still in relatively early stages.
Having said that, we know that Bitcoin’s price has been cyclically volatile with several examples to highlight. In early 2013, the value rose from $15 to a peak of $266 before crashing to around $50. In 2018 Bitcoins price rose to $20,000 per bitcoin and then subsequently fell to $6,0000 levels.
Bitcoins price has fluctuated wildly over the years, but what are some of the factors that cause this?
Volatility main factors
1. News events – because Bitcoin is still a relatively new concept, what people read in the news can have a significant effect on the price. We’re talking about geopolitical events, government statements about regulations, and even rumours spread through social media. Incidents that cause public panic and instill fear in the stability of Bitcoin can drive down its value rapidly.
2. Perceived value vs. fiat currency – bitcoin has similar properties to gold; for example, they both need to be “mined’ and they are both available in limited quantities. Bitcoin is governed by a design decision to limit the production to a fixed amount (21 million BTC). This is a contrast to fiat currencies, which are managed by the government who have several factors to consider (maintaining high employment, low inflation, etc.). Therefore, as fiat currencies display signs of strength or weakness, this may influence how people choose to invest their respective assets.
3. Forks – when there are differences among developers that result in incompatible versions of the software occurring at the same time. This causes confusion about the state of the blockchain. Consequently, volatility increases as traders try and predict what will happen and trade appropriately.
4. Whales – a few individuals or entities who own a large proportion of Bitcoin. When they place huge orders on spot exchanges, these movements can affect the entire market.
5. Liquidity – or the ability of an asset to be converted into another coin or cash. Another way to look at this is to ask how easily can the asset be sold or bought at its fair price. To have high liquidity, there must be enough buyers and sellers ready in the market. If there is a large trade proposed, but not many buyers and sellers, the price can change significantly to complete the deal.
6. Market size – the price of Bitcoin fluctuates with supply and demand, just like any other market-traded value. People buy and sell at the prices they are comfortable trading at. If for one reason or another, there is more buying pressure and people buying more bitcoins, prices will increase. Conversely, if there is more selling pressure and people selling their bitcoin for fiat currencies, the prices will fall. In comparison to the rest of the asset world, Bitcoin is still tiny, and this means that all the other factors that affect volatility are amplified.
What does the future of Bitcoins volatility look like?
As Bitcoin is still in its early stages as an asset, as with all new technologies, nobody can be sure what it’s end-use will be. Today, this uncertainty affects the narrative, which impacts its valuation and therefore results in waves of volatility. These severe waves will eventually break once bitcoin’s role is firmly set in society. As regulations are refined, adoption and institutional investment are increased, people will start to confidently trust and recognise the value of Bitcoin as an alternative asset class, and volatility will ultimately decrease.