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Why Is Bitcoin So Volatile?

By December 2, 2021September 18th, 2023No Comments10 min read

Bitcoin And Volatility

When the demand for a cryptocurrency like Bitcoin exceeds the supply, the price tends to go up. When its supply exceeds demand, the price goes down.

Bitcoin has always been a highly volatile commodity. In truth, cryptocurrency is one of the most volatile non-derivative financial assets on the market. Every day, Bitcoin swings by more than 3% on average. Despite having by far the largest market liquidity of any cryptocurrency, it’s also times greater more costly than fiat currencies. Bitcoin, which libertarians have embraced enthusiastically, has been heralded as the route to financial independence. Decentralized innovation on borderless software systems has given rise to new paradigms of thought and creativity. Global collaboration has reduced financial barriers while also promoting individual potential.

“Volatility is a measure of how much the price of an asset has moved up or down over time. Generally, the more volatile an asset is, the riskier it’s considered to be as an investment — and the more potential it has to offer either higher returns or higher losses over shorter periods of time than comparatively fewer volatile assets.” – Coinbase.

bitcoin cryptocurrency

Stocks are considered to have a wide range of volatility, from the relative stability of large-cap stocks (like Microsoft or Amazon) to more unstable “penny stocks.” Bonds, on the other hand, are a lower-volatility asset, with less severe upward and negative fluctuations over longer time periods.

While market volatility provides opportunity for traders to boost their value, its downsides must not be ignored. One of these is that it prevents crypto from being used in real-world applications. Cryptos, for example, struggle to fulfil the function of a currency because to severe price volatility. If you are a business and decide to price your items in Bitcoin, you may earn massive gains or big loses in a matter of minutes. After you’ve sold an item, the value of the money might swing dramatically higher or downwards.

Another negative aspect of volatility is that long-term investors or those who want to hold bitcoin as a store of wealth may find it difficult to predict its future performance. Some see volatility as critical to the growth and interest in bitcoin, while others see it as the reason cryptocurrencies have failed to fulfil critical functions and disrupt specific industries, such as being a practical and viable digital currency.

bitcoin cryptocurrency

Here Are The Main Reasons Why Bitcoin Is Volatile

Here is a quick summary of the reasons which will be further discussed:

1. Lack of Regulation

2. The Sentiment Factor

3. Limited Supply Of Bitcoin

4. Bitcoin Speculation

5. The Media and Bitcoin

6. The Bitcoin Investor Profiles

1. Lack of Regulation

Unlike other asset classes that are governed or controlled by any institution, Bitcoin is not governed or controlled by any entity. This is what makes crypto different from fiat currency, stocks, or bonds. The anonymity is what either attracts or repels investors. Their price is determined totally by the rules of supply and demand.

Because blockchains are distributed across many distinct systems all over the world, Bitcoin does not have a single centralised location. As a result, established regulatory systems find it difficult to manage them. There are several examples of a cryptocurrency’s growth being stifled because of a government tightening its crypto laws. For example, the recent restrictions imposed by China contributed to a period of severe volatility in Bitcoin prices.

2. The Sentiment Factor

The first and arguably most significant aspect of Bitcoin to understand is that it has no intrinsic value. This means that typical valuation methodologies, such as discounted cash flows, cannot be used to quantify it. While Bitcoin is frequently compared to gold in terms of being a “store of value,” it lacks physical existence.

More investors will recognize the elements that drive the movement of crypto currencies as they become more popular and acknowledged. Until then, much of the activity is speculative, with investors buying and selling depending on opinion.

Those who intend to own cryptos for the long term, are doing so as they believe that the asset class will gain acceptance.

3. Limited Supply Of Bitcoin

Bitcoin is a finite digital commodity; hence its price should appreciate in comparison to non-finite fiat currencies over time. Bitcoin’s supply is limited to 21 million, but because it is one of the most popular cryptocurrencies, demand and supply dynamics come into play. For comparison, Litecoin has a maximum supply of 84 million coins, whereas Chainlink has a limit of 1 billion.

However, volatility is also the price that Bitcoin investors pay for its limited supply and the lack of a central bank to oversee that supply. That is precisely the characteristics that proponents its value. Miners who contribute their processing power to verifying transactions throughout the decentralised network are rewarded with new Bitcoins. The size of these incentives declines with time, so each completed transaction compensates miners less than it used to. As a result, Bitcoin’s supply is completely inelastic. The route to accurate price discovery is frequently paved with seismic price fluctuations.

4. Bitcoin Speculation

Speculation is a major source of volatility in the Bitcoin market. Indeed, it is volatility that attracts speculative traders trying to make great money by guessing the swings.

There is no physical asset to back up the value of Bitcoin, nor are governments obligated to enforce its usage as a currency. Their worth is solely dependent on faith. If consumers lose faith in Bitcoin’s ability to keep or gain in value, they will most likely sell. This can lower the price and persuade others to sell as well. Activity like this leads to cycles forming which rapidly lowers the price. The opposite can also happen to shoot prices up and form over-inflated price bubbles.

However, 2019 will be a totally different year for the cryptocurrency sector. Speculative investing is no longer popular, and instead, consumers are seeking for cryptocurrency functionality. This has given rise to the “stable coin” movement, which has spread to Wall Street and JP Morgan Chase.

5. The Media and Bitcoin

This is connected to speculation. Bitcoin is a small market of digital assets with a lot of speculation and the media has a huge influence on where the values trend. Speculators and investors are always scanning the headlines for the next big story that will either rocket or wreck the market. When something does emerge, everyone understands that it’s a race to buy or sell. The fastest will profit the most and the slowest losing the most.

The media’s coverage of Bitcoin has a substantial effect on its price. It doesn’t help that many people in the cryptocurrency business obtain their news from dubious sources and social media.

Bitcoin skyrocketed in value over a very few years to be worth of $20,000 offering many thousands of percent gains for those who invested early. These stories permeated the mainstream, and suddenly everyone wanted to know what Bitcoin was, what Blockchain was, and how they could be a part of this get-rich-quick scheme. That interest alone fuelled the price rise even further. It became a snowball effect in the shape of a speculative bubble.

6. The Bitcoin Investor Profiles

Unlike other markets such as real estate, the barriers to entry into Bitcoin trading and investing are low. To invest, you do not need a lawyer, a trading licence, or a certain quantity of funds. Anyone with a few dollars and an internet connection can begin trading right away. The average investor in the bitcoin market has significantly less experience and knowledge than in most other sectors. As a result, the cryptocurrency markets are especially susceptible to hype, FUD (fear, uncertainty, and doubt), and blatant manipulation. Crypto traders frequently panic in instances when experienced traders might maintain their composure.

Bitcoin is the market of choice for millions of inexperienced traders all over the world. Institutional investors are wary of the crypto market. Many people believe it is way too hazardous to even consider going near it, let alone spend significant wealth in it. The more retail investors who enter the market, the scarcer and more inexperienced the market becomes, worsening volatility. Volatility is one of the most important variables in determining investment risk. Traditionally, investors will take on a high level of risk if they believe the potential reward is worth the possibility of losing some of their investment.

However recently, Bitcoin trading is no longer dominated by retail buyers. As more institutional investors adopt bitcoin, it lends newfound legitimacy to the cryptocurrency. This helps to erase its reputational risk. It also creates more stability overall.

bitcoin cryptocurrencyAre There Ways To Reduce Bitcoin Volatility?

Extreme volatility is appealing to some Bitcoin investors because it presents the chance of high gains. Even though Bitcoin’s volatility appears to be decreasing, it frequently fluctuates by double digit percentages in a single week, allowing for techniques such as “buying the dip.”

There are measures, such as dollar-cost averaging, that can be used by less risk-averse investors to mitigate the detrimental impact of volatility. Long-term investors who have solid reason to assume that an investment will eventually rise in value don’t need to worry about short-term volatility as much. There are currently stable coins, which are cryptocurrencies particularly engineered to have low volatility and have their price pegged to a reserve asset such as the US dollar.

Because of the damage that huge fluctuations can cause to portfolios and livelihoods, rules have evolved to minimize volatility. You may recall that during the GameStop surges, trading on the stock was regularly halted due to severe market moves. To take one example, the New York Stock Exchange has market-wide circuit breaker mechanisms in place to either temporarily suspend individual stocks or close the entire market if certain criteria are met. Investors have no recourse in this situation. These restrictions arose because of the perception that volatility is undesirable. This anti-volatility attitude can be found across mainstream coverage of this week’s crypto market rout and recovery. Volatility, however, is not a fault for Bitcoin investors who have been in the market for a time. It is rather a feature, and not simply because of the potential for outsized rewards. It’s also a selling point because it emphasises the market’s comparatively unique independence. Bitcoin is volatile because there is no central authority to keep it that way. As a result, Bitcoin prices can be expected to reflect investor opinion more accurately. This gives an idea of what a “pure” market may look like.

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