Why Does Bitcoin Value Have such High Fluctuations?
The number of people using Bitcoin is steadily increasing as more excitement builds around the possibility that the currency’s value will soar in the coming years. The enthusiasm surrounding Bitcoin’s adoption is due to the hope that as a store of value, it will yield handsome returns sometime in the future. The other reason is Bitcoin’s novel features that set it apart from traditional currencies – features such as decentralization, peer-to-peer nature, and transparency of transactions.
Bitcoin is also seen as trustworthy, something that cannot be said of Fiat currency, which is released and controlled by governments and central banks. This is why it has become the go-to currency for citizens living in nations whose currencies have been rendered useless by hyperinflation. Bitcoin also provides a faster and cheaper option to send money overseas.
But Bitcoin has its shortcomings too. A persistent one is its volatility or pretty unpredictable price fluctuations. What this means is that these fluctuations can bring pretty handsome payoffs or wipe away your investment in one swoop.
At the core of all this is the question: what causes this volatility? What factors conspire to make Bitcoin’s price so slippery? This article dives into the whys and whats of this phenomenon. But first, let’s get a refresher of what volatility in Bitcoin is.
What’s Volatility in Relation to Bitcoin?
First, let’s define volatility. In finance, we say an asset is volatile if its price is often difficult to foresee – meaning it fluctuates a lot in a relatively short time. Such an asset may move up or down in pretty significant variations within that time. However, there’s no definition for what constitutes a ‘significant variation,’ it’s subjective. However, industry experts and investors can agree that if an investment is particularly risky, then that asset is volatile. Going by this definition, then Bitcoin is undoubtedly volatile. Its price undergoes massive swings within a few days, hours, and sometimes even minutes.
With that, let’s examine why.
#1. Market Manipulation
The Bitcoin market is prone to manipulation courtesy of lack of regulation of the market that’s caused the decentralized nature of the currency. Indeed, there are well-documented incidents of the coin’s manipulation in the past.
Since buying and selling of Bitcoin is largely unregulated, it provides fertile ground for bad actors to manipulate the price and cash out rich long before other market players can catch on. This sort of thing contributes to Bitcoin’s volatility.
#2. News Events
Good news or bad news can significantly contribute to the movement of Bitcoin’s price. When news surrounding Bitcoin is positive, it can increase investor confidence and lead to more market participants purchasing the coin, bumping its price higher.
By contrast, bad news concerning Bitcoin can sink the coin’s price. For instance, $72 million worth of Bitcoin was stolen from crypto exchange Bitfinex in August 2016. The same day, the price of Bitcoin took a 20% dive.
Other types of news items likely to affect bitcoin’s price include state or government’s new regulation plans, statements by influential figures in the finance and investment worlds, security breaches, rumors, and misinformation.
#3. Changing Sentiment
Another driver of Bitcoin’s volatility is a change in sentiment concerning the currency. Positive news events can cause market participants to be optimistic or pessimistic about the coin and its future prospects.
General positive sentiment in Bitcoin would prompt increased demand and an upswing in price. Other factors like price gains, combined with the media coverage surrounding those gains, can trigger more price appreciation and hence buying, causing the price to go up.
Similarly, negative sentiments would have the exact opposite effect on the price direction. For instance, a price fall would trigger an unfavorable news cycle, causing individuals to offload their holdings or keep away from the market altogether.
#4. Uncertainty over Bitcoin’s Future Value
This is another major factor driving the volatility of Bitcoin. Uncertainty in the currency’s future is caused by the differing views on the intrinsic value of Bitcoin. From the very beginning, questions have been raised about the fundamental value of the currency. It not being a tangible currency, and having no issuing authority makes it look like a joke to some people.
There’s also the regulatory aspect of the market. As more governments and states move to crack down on cryptocurrency, it can cause many to question how long the coin will hold as an attractive investment that cannot be touched. In such instances, Bitcoin might lose its appeal, and more market participants would be uncertain of its future value.
It’s easy to forget sometimes that Bitcoin is just code – open source code for that matter. This means that developers can modify the code at any time to suit a particular end. When the Bitcoin community irreconcilably disagrees on something, it can lead to the blockchain being split into two, with one faction going one way and the other faction the other.
When forks happen, the new direction of each new blockchain is uncertain at best. As a result, forks, and the emotions surrounding them, can cause volatility as investors rush to reassess their position in the face of a permanent change. For instance, when Bitcoin Cash forked from Bitcoin, Bitcoin dropped from $2800 to $2700 (July 23, 2017).
#6. Inequality in the Coin’s Distribution
Bitcoin is extremely unevenly distributed, another factor that could fuel its volatility on occasion. Former managing director and head of financial markets research for AQR Capital Management Aaron Brown estimated in 2017 that only 1000 individuals owned approximately 40% of all bitcoins in circulation then.
Other sources have arrived at varying figures, but they all point to the same extremity in which the small minority of the coin’s holders own the largest share. If a single individual/entity possesses a substantial amount of Bitcoin, they can trigger a major fluctuation by offloading even a small portion of that amount. The effect would even be greater if such entities were to liaise to cause significant shifts in the price.
#7. The Tech is Still Young
The underlying technology of Bitcoin is still relatively young – just slightly over a decade old. For this reason, it will be a while before it fully matures and overcomes some of its most persistent challenges, such as scalability.
When Bitcoin was breaking out and gaining traction, it gained more users – but it soon became evident that the network could not support a large volume of users at once. These days, it’s possible for a Bitcoin transaction to take even days before it’s completed. Situations like these could discourage users from joining the network, causing a slump in the currency’s price.
The IRS considers Bitcoin a taxable asset. This has affected Bitcoin’s price in more ways than one. First, it has added a whole complexity for users who want to have it as a store of value, a means of getting paid, and so on. The tax law requires users to record the market value of the coin at the time of the transaction, and enter taxes in Fiat form. This need to enter tax records every time can prove to be more trouble than worth for current and would-be users of Bitcoin.
Also, the decision by tax authorities to tax Bitcoin can signal to potential users that stronger regulation policies are in the cards, and this can send many scurrying in the opposite direction. Extremely strong regulations would stifle the growth of the currency, preventing it from ever achieving mass adoption. This could cause many users to lose faith in the future of the currency, causing a slump in price. Also, the communication surrounding the taxation of the currency can be confusing to many users. The unenthusiasm stemming from this could contribute to Bitcoin’s volatility.
#9. Emotions and Investing
Investing in Bitcoin can often have so many emotions involved, and this is only exacerbated by its already volatile reputation. When the currency’s price drops, investors will panic and experience fear, uncertainty, and doubt (FUD). They fear the price will only drop further. They are uncertain if it will ever recover. They doubt their investing acumen. So what do they do? They sell their holdings. This won’t have been triggered by an actual change in the coin’s value, but rather by emotions. The effect is that Bitcoin will experience a tumble.
Another scenario is when the price of Bitcoin is on an upward trend. Individuals will get excited and experience the fear of missing out (FOMO). They fear that if they don’t buy now, they may miss out on getting rich. So they rush and purchase Bitcoin, and the overall market effect of all this buying is increased demand and price. Naturally, the price will shoot up.
So there you have it. Knowing the triggers of Bitcoin’s volatility will help you be more aware of the events surrounding it, and this helps you make wiser decisions as far as speculating in the currency is concerned.