Why does Bitcoin's value fluctuate? Why will it continue to fluctuate? Simple! It's because that's what small caps do! It's what they've always done and always will do, and here's why. Bitcoin fulfills two functions; it is a currency and it is also an investment. As a currency, it fulfills many of the functions and behaves like, well, a currency. As an investment, it fulfills many of the traditional functions of an investment. It behaves in a similar way to traditional investments, namely stocks and bonds, that gives it volatility. In order to explain why this happens, and why it is important, I am going first to set a few rules. In my humble opinion, the best book ever written on investing is the good old reliable "Common Stocks and Uncommon Profits" written by Philip Arthur Fisher, and first published way back in 1958. Some of the figures I quote may seem small, and in the period 1995-2005 those thresholds may have been bigger, but the intervening decade has not been kind to Wall Street. The Bears have done well.
First, when we look at buying into a stock, we look at ownership of that company and not just having a tiny share in it. You should ask yourself: "In this case: What would Warren Buffett do?" Let us begin by categorising the companies into various sections. Now the key phrase here is Market Capitalisation. This figure is the total number of shares in existence multiplied by the market value of a single share. If a company has Two Million shares selling at $1.90 each, then the Market Capitalisation, or Market Cap, would be $3.8 Million, If the shares take a bath to $1.35 then the value of the market cap. would be $2.7 Million. Now, considering market cap and it's role in volatility.
(1) Micro-cap: (Below $250 Million) These companies have the smallest capitalisation and are the riskiest stock you can invest in. They can be great and have huge potential for growth. They have a bad history of going belly up though. Huge volatility!
(2) Small-cap: ($250 Million to $1 Billion) This category is more stable than Micro-cap, they are still very volatile. They still have the potential for great growth, but in investments, there's no guarantees. Less volatility than Micro cap though.
(3) Mid-cap: ($1 Billion to $5 Billion) These stocks tend to be a safer bet, they have stability that the smaller caps. don't have and still have the potential for strong growth. Mid-cap companies are watched by wolves, however, whereas the smaller caps can sometimes be overlooked. Always remember, the small fish in the ocean are often attracted by something that looks tasty and swim right up to an anglerfish and becomes its dinner. Be careful. These investments have less volatility; they are quite stable really, and there is always that attractive growth potential.
(4) Large-cap: ($5 Billion to $25 Billion) Welcome to the 'Blue chips', These companies are huge and give stable if smaller returns. Conservative investors love to hedge their investments with these. These companies tend to be seen as safe bets. Little short-term volatility.
(5) Ultra-cap: ($25 Billion plus) Household names, sometimes known as 'Mega Caps'. These are truly massive organisations, tend to be multi-nationals, these are the companies that have the potential to cause a national crisis when they pull out of a country. Very stable price with extremely small volatility.
Now, if we take a figure of $500 as the value of a bitcoin. Then the market capitalisation would be: the amount in circulation, which is circa 12.5 Million. (The number is not 21 Million as this is the potential circulation and not the circulation at this point in time.). So, we therefore have 12.5 Million bitcoins at an estimated value of $500; This gives a market cap. of 6.25 Billion. Therefore, we would reasonably expect Bitcoin to behave like a blue chip, large cap, company. Why does it not behave like this?
To answer this, I intend to ask the question: Why are some new company values lower than others? Let me offer two scenarios: One, maybe investors are slow to come on board because the company is working in a completely new area, and investors aren't sure of the industry's potential. Examples of companies that went through this phase would be Facebook, Twitter and Bitcoin. Another reason that investors would be slow to come on board would be that the company is a new entrant in an established industry and investors are not sure how they are going to do. Examples of this would be, a new exploration company, a new short-haul airline, Amazon would have been an example of this. As investors become more confident, they tend to come on board. Therefore, we must treat Bitcoin as a 'new' company in a new industry. We are a company with a large market cap. but the Market treats us as a small cap through lack of knowledge. Investors hate uncertainty.
Now, investments are generally longer term, and this means that any market entry from the major investors will be slow and careful. Volatility is going to be their friend as more investors, that don't understand volatility, move to hedge their bets into cash. Bitcoin is still new, and we must remember that it behaves like any new stock will behave. Whenever you become uncertain, remember this example, two trees are standing one mile apart; one is a strong two-hundred year-old oak, the other is a five year-old oak stripling. After a period a storm comes along, The old Oak has been through many storms and its foundations are strong. The storm hasn't a great effect on the old Oak. The stripling is tossed and twisted, it almost gets stripped of all its leaves, and the storm sets it back, but it too survives. The storm had little effect on the old tree and a huge effect on the oak stripling. Now ask yourself this: the storm aside, which tree has the greatest long-term potential for growth?
That's where Bitcoin is at. This is simply where we are and what we do. Let us just not forget it.
Image courtesy of Jonas Smith.