Think of Bitcoin’s price as a cork in a stream. The lightest touch will send it plummeting below the surface of the water, but its internal buoyancy (with the analog being it’s enthusiastic support of its core base) will send it bouncing back before settling at an equilibrium. If anything, cryptocurrency volatility is considerably simpler to understand than stocks, because overall, they’re a raw representation of the forces of supply and demand and lack all of the extra institutional craziness that comes along with big name stock. There’s no central bank affecting interest rates, no tax-rate factors to consider, and no inflationary pressures, among other things, influencing the price.
When cryptocurrencies are launched, they tend to be extremely volatile because they are thinly traded markets. A thin market refers to the size of the order book, and an order book refers to the list of buys and sells on an exchange. Essentially, it’s the measure of the number of people wanting to buy and sell at any given moment.
This thinness can also be referred to as the liquidity of the market. If the market is highly liquid, then there are lots of orders and a few of them are likely large. In this case, value can be easily traded. If the market is illiquid, or thin, then sizeable price swings with low volume will occur because someone trying to buy (or sell) a lot of the asset will fill all the available sell (or buy) orders, which drives the price up (or down).
Volatility is most commonly derived by taking the standard deviation of the daily percent price changes. The bigger this number is, the more the investor can expect significant price swings in the asset they’re holding, and therefore, the bigger the risk.
The order book will fatten over time and volatility will decrease.
Here’s Bitcoin’s lifetime chart. Note the crazy jags and spikes in the early years, and how comparatively flat the price has gotten in the past few years.
Sudden spikes either up or down in bitcoin price usually have pundits scratching their heads as to finding the cause. The problem is that there are usually plenty of different reasons why the price will move, and it comes down to investor sentiment. The two old investment standbys: fear and greed.
Sources of volatility
Donald Trump says he doesn’t like Bitcoin and thinks it’s a useless go-nowhere asset, or says anything vaguely negative about cryptocurrency, and people either buy or sell depending on how they feel about the orange buffoon.
That’s an example of how news can affect the price.
A better example might be China. The country has outright banned cryptocurrency (while embracing blockchain) and any kind of negative (or positive) news could trigger a buying or selling spree. I heard an interesting rumour this week that the December 2017 spike and crash were precipitated by Chinese investors bailing out of their Bitcoin because President Xi Jinping said he wasn’t a fan.
Then there’s internal news, like how last year this week users of Bitcoin Cash (BCH) tanked the price of Bitcoin because of of BCH’s hard fork into Bitcoin Cash Satoshi Vision and Bitcoin Cash ABC. Why this would make the holders of the original stake given that Bitcoin has nothing to do with BCH or the other two coins, is beyond me, but nobody ever said cryptocurrency investors were coherent.
- Uncertainty about Bitcoin’s future
Volatility can be driven by perceptions in the value of the currency as a store of value and method of value transfer. It’s not a bad call, to be honest. Cryptocurrency has a scaling problem—that much is evident. Transactions take too long because with every coin thus far it takes too long to close a block, and while it seems every blockchain company out there today claims some level of resolution to this problem, none of them have come forth with a workable solution. Until that happens, people are going to keep going to VISA (V.NYSE) or Mastercard (MA.NYSE) or their bank debit card using fiat cash, then using any cryptocurrency to buy their morning coffee.
- Security breaches
Technically, when Gerald Cotten died while on vacation in India, and QuadrigaCX, his Vancouver-based exchange, became an infamous overnight failure in the history of cryptocurrency, it wasn’t a security breach. But it did have a large effect on cryptocurrency, Bitcoin and otherwise, because of the perceived insecurity of the exchange, which could then be extrapolated to the insecurity of every other exchange.
Security breaches in this case refer to hacks—which of course hearkens back to the two types of exchanges, which I can’t stress enough. 1. Those that have been hacked. 2. Those that will be hacked.
The number of exchanges that have been hacked grows everyday, mostly because crypto-newbies make mistakes, but sometimes because there’s a weakness in an exchange’s code. The former mistake is made far more often than the latter.
- High profile losses raise fear
Most of these categories listed here in this article aren’t mutually exclusive. There’s a lot of overlap. For example, when Binance was hacked earlier this year to the tune of 7,000 bitcoins, which was 2% of the company’s total holdings, it caused a substantial dip in Bitcoin’s overall price to USD$9,530.779 as people bailed out of the currency.
The security breach fired up the fear-centres in their brain, and they went to their favourite exchanges and sold their bitcoin holdings for fear that they were next. It’s not exactly logical, but it’s also not entirely unreasonable. We’re humans and fear of losing out is only second to the fear of missing out, which is why a lot of people get involved in the first place.
For every fear of losing out and the attendant guilt and shame that comes along with the fear of losing money on your crypto-investments, there’s one person that’s got the opposing bit of fear and shame: specifically, the fear of missing out. It’s the opposing side of negative volatility—the upward spike the accompanies a bull run. All your friends are in it, and CNN’s been talking about it, and what’s this Bitcoin thing all about? Maybe it’ll stall people from doing their due diligence and discovering whether or not this bitcoin thing is a good investment for them, especially if all their friends are bringing in substantial returns on their initial investments.
- High inflation nations and Bitcoin
Bitcoin has different use value depending on where you are in the world. For example, in Argentina right now, the country is experiencing economic hard times due to a hyperinflated currency. Their economy has been gutted and cryptocurrencies like Bitcoin are actually less volatile than the Argentine Peso. There’s also something to be said about the international infrastructure (or maybe lack thereof) regarding cryptocurrencies and Bitcoin in particular when it comes to serving asa potentially attractive borrowing instrument for Argentinians. The high inflation rate for peso-denominated loans potentially justifies the volatility risk in a Bitcoin oriented loan funded outside of Argentina.
The final word
The final word for right now is that crypto volatility is a fact of life for cryptocurrency enthusiasts and will be for the foreseeable future. But we know this. We’ve created internet memes about the intestinal fortitude requires to sink so much of your risk portfolio into this volatile currency. We should probably point out that the final word isn’t the final word on volatility. The above examples of the origins of volatility is only the most common in what is essentially a long, non-exhaustive list.
But as the halving approaches and we enter into the unprecedented new age post-halving, where the resistance price goes from low five-figures (CAD) to wherever it lands next after the bulls are done with it, we’ll see new sources of volatility, and we’ll be sure to chronicle them here as they occur.
So stay tuned and keep hodling.