A Comprehensive Guide To Why Is Bitcoin Volatile?
A Comprehensive Guide To Why Is Bitcoin Volatile | Credit: Shutterstock
Key Takeaways
- Bitcoin’s price volatility arises from supply and demand shocks, its scarcity, and the macro environment that it is disrupting.
- Factors like market maturity, regulation, technology, adoption, and reduced bear market crashes may stabilize Bitcoin’s volatility.
- Predicting Bitcoin’s future price is complex due to sentiment, adoption, tech changes, and external events.
- Volatility offers trading opportunities, long-term investment potential, price discovery, and fosters education and awareness.
Why Is Bitcoin Volatile?
In 2008, Satoshi Nakamoto introduced the Bitcoin white paper . By 2009, the initial value of Bitcoin blockchain was only a fraction of a cent, reflecting the cost of electricity used to mine the first few million coins. However, a single Bitcoin’s valuation soon rose to $0.09c .
Bitcoin has since come a long way providing real-time global market value through its decentralized network, allowing users to track transactions and account balances with unparalleled transparency. The cryptocurrency is governed by a protocol and open-source software which ensures security and reliability of the system.
Moreover, Bitcoin’s monetary policy self-induces supply shocks called the halvings every four years, reducing the rate at which new Bitcoins are created enhancing its scarcity principles, making it an attractive store of value for investors. Due to its startup nature, with just a 14 year lifecycle, Bitcoin is also known for its volatility in price swings making it a highly speculative asset. Here are some reasons for Bitcoins Volatility:
Demand And Supply
The prices of most commodities like precious metals are primarily shaped by the forces of supply and demand. Bitcoin’s market value is mainly influenced by the supply of coins in circulation and the willingness of individuals to invest. With a predefined limit of 21 million coins that will ever exist, and 19.5 million coins currently in circulation the supply is being constricted each market cycle, also known as the halving which occurs every four years.
Scarcity
In the United States, there are approximately 22 million officially recognized millionaires , indicating that there isn’t sufficient Bitcoin for each millionaire to possess a whole coin. Bitcoin serves as a store of value, and in times of geopolitical uncertainty, when businesses or individuals seek to protect their assets, the demand for Bitcoin will continue to rise. This heightened demand, coupled with its limited supply, can lead to significant price volatility.
Market Speculation
Bitcoin, being relatively new in the financial landscape, is highly susceptible to speculative trading. Traders often respond to market sentiment rather than fundamental factors, leading to rapid price swings.
Lack Of Institutional Regulation
Unlike traditional financial markets, Bitcoin operates with minimal regulatory oversight in many regions. This absence of institutional control makes it susceptible to sudden large trades or speculative bubbles, with large upside but also extreme bear downsides, contributing to volatility.
Market Sentiment
Investor sentiment can be a significant driver of Bitcoin’s price swings. Positive news or endorsements can lead to price rallies, while negative developments can trigger sharp declines, reflecting its sensitivity to external sentiment factors. The halving is deemed to be a bullish event because its presence amplifies the education surrounding Bitcoins scarcity.
Whale Behavior
Bitcoin whales, with substantial holdings, can impact the market significantly. Their buying or selling decisions can lead to cascading effects, amplifying price volatility as other investors react. For example, if each millionaire wants one coin the price of each coin will increase because each millionaire will have to outbid the other leading to volatility.
External Events
Geopolitical tensions, regulatory changes, and macroeconomic factors can influence Bitcoin’s volatility. As Bitcoin is considered a hedge against traditional financial systems, any events that threaten these systems can lead to increased demand, driving up prices, or panic-selling, causing abrupt drops.
Lost Bitcoin
Various estimates suggest that a significant number of Bitcoins have been lost over the years due to a variety of reasons. Estimates suggest that a significant portion of the total Bitcoin supply, possibly 4 million Bitcoins or more, has been permanently lost.
These lost coins reduce the effective supply of Bitcoin in circulation, further amplifying its price volatility. As the demand for this digital asset surges, its relatively limited supply, exacerbated by the prevalence of lost coins, can result in sharp price fluctuations.
Will Bitcoin Remain Volatile Over The Next 14 Years?
Bitcoin is likely to hold a degree of volatility that will always be present in the Bitcoin market, but the extent and nature of that volatility can evolve over time. Here are some key considerations that argue a more stable price in the future:
Market Maturity
As Bitcoin continues to mature and attract more institutional investors and widespread adoption, it’s possible that its price volatility could decrease. Established financial instruments, such as futures and options markets, can also help stabilize prices by providing tools for risk management.
Regulation
Increased regulatory oversight and clarity can bring more stability to the market by reducing uncertainty and deterring manipulative practices. However, excessive regulation can stifle innovation and adoption, so it’s a delicate balance.
Technological Advances
Improvements in blockchain technology, scalability solutions, and the development of second-layer protocols (e.g., Lightning Network) could enhance Bitcoin’s utility as a medium of exchange, potentially reducing its speculative volatility.
Market Adoption
Wider adoption of Bitcoin in everyday transactions can reduce its dependence on speculative trading and increase price stability. As it becomes more commonly used as a currency, its price may stabilize.
External Factors
Geopolitical events, economic crises, and global financial instability can still impact Bitcoin’s price, contributing to volatility. These factors are challenging to predict or control.
Bear Market Crashes Are Reducing
The Bitcoin chart below illustrates the historical behavior of price crashes during past bear markets, revealing the substantial percentage drops in value. In the first bear market, the price experienced an 85% decrease, followed by an 83% drop in the second one, and a 76% decline in the third.
Looking ahead, there is a prevailing expectation that this pattern of decreasing percentage drops may persist in the future, potentially signifying a gradual reduction in overall market volatility along with this reduction. This trend suggests that as cryptocurrencies like Bitcoin continue to mature and gain wider acceptance, they may become more resilient to extreme price fluctuations, ultimately leading to a more stable investment landscape.
Bitcoin Is Still In Its Infancy
Bitcoin is still a relatively new concept and young asset class and in the process of price discovery. Consequently, its value is subject to continuous adjustments as investors, users, and governments grapple with initial challenges and uncertainties, making it an evolving and dynamic asset class.
How Can Bitcoin Volatility Be Beneficial To The Individual?
Whilst volatility can be initially viewed as a challenge it may also present itself as a huge opportunity to learn more about markets and churn out gains in the process. Some benefits behind volatility include:
Trading Opportunities
Volatility creates frequent price swings, offering traders opportunities to profit from both upward and downward movements. Skilled traders can employ strategies such as day trading, swing trading, or arbitrage to capitalize on these price fluctuations.
Long-Term Investment In A Speculative Asset
Some investors embrace Bitcoin’s volatility as a long-term investment strategy. They buy and hold, believing in the cryptocurrency’s potential for significant appreciation over time, despite the short-term price fluctuations.
Price Discovery
Volatility assists in the price discovery process, as it reflects changing market sentiments and information. This can lead to more accurate and efficient pricing over time.
Education And Awareness
The Bitcoins market’s volatility often attracts media attention, fostering education and awareness to the digital asset class and to blockchain technology.
Challenges And Risks Associated With Volatility
There are some inherent risks surrounding volatility that an individual should mitigate against. These include:
Investment Risk
High volatility means that Bitcoin’s price can change rapidly, leading to significant gains or losses for investors. This risk can be a deterrent for some investors.
Use As A Currency
Volatility can make Bitcoin less suitable as a medium of exchange or store of value, as its value may fluctuate significantly over short periods.
Regulatory And Institutional Concerns
Extreme volatility can raise concerns among regulators and institutional investors, potentially leading to increased regulatory scrutiny or hesitation to invest.
Consumer Confidence
Rapid price swings can erode consumer confidence in Bitcoin’s stability and usability for everyday transactions and overall belief.
Conclusion
Bitcoin’s volatility is a hallmark of its health within the cryptocurrency ecosystem, reflecting its disruptive nature and its potential to reshape the world of finance as we know it. This dynamic characteristic draws traders, investors, and innovators, propelling the evolution of the digital asset landscape.
As such, the perception of Bitcoin’s volatility varies among market participants, with its significance evolving over time in tandem with the cryptocurrency ecosystem’s development.
FAQs
Why Is Bitcoin Volatile?
Its price is mainly influenced by supply and demand dynamics, scarcity, speculative trading, lack of institutional regulation, market sentiment and the prevalence of lost Bitcoins, among others.
Will Bitcoin Remain Volatile Over The Next 14 Years?
Factors like market maturity, regulation, technological advancements, increasing adoption, and a historical trend of decreasing percentage drops in bear market crashes suggest the potential for a more stable price environment in the future.
How High Can The Price Of Bitcoin Reach?
Predicting the future price of Bitcoin remains uncertain and challenging. Bitcoin’s price is subject to various factors, including market sentiment, adoption, technological advancements, and external events.
How Can Bitcoin Volatility Be Beneficial To The Individual?
Bitcoin’s volatility presents trading possibilities for profit, long-term investment potential, aiding price discovery, and fostering education and awareness.
