Why is bitcoin so volatile?
A Bitcoin logo displayed on a smartphone with stock market percentages in the background in this illustration taken on April 26, 2021.
Omar Marques | SOPA Pictures | LightRocket | Getty Images
So you want to play crypto and become a millionaire overnight? Get ready for more days like Wednesday.
Bitcoin plunged 30% to around $ 30,000, according to Coin Metrics. Ether fell more than 40% in less than 24 hours, dropping below $ 2,000 at one point. Both regained ground at the end of the day.
But that’s normal in the world of cryptocurrency trading. Huge surges and equally drastic falls. Again and again.
“Massive retracements are always scary, but seasoned investors tend to see them as buying opportunities,” said Mati Greenspan, portfolio manager and founder of Quantum Economics.
Crypto and market experts tell CNBC that this is the new standard for investing and traders should just get used to it.
Value and volatility
Bitcoin’s volatility has to do with a lot of things.
On Wednesday, for example, news from China cracking down on banks doing crypto transactions, as well as tailwinds from Tesla’s decision to no longer accept bitcoin as a form of payment has certainly helped cause the carnage among digital currencies. The overall crypto market was also likely to undergo a correction after weeks of record highs inspired by tweets, thanks to Elon Musk.
But volatility is also the price bitcoin investors pay for its limited supply and lack of a central bank to control that supply – precisely the characteristics that proponents say make it valuable.
Part of what makes bitcoin valuable is the fact that it is scarce. There is 18.7 million bitcoin in circulation, which is approaching its maximum threshold of 21 million.
New bitcoins are created to reward miners, who contribute their computing power to verify transactions on the decentralized network. Over time, the size of these rewards decreases, so each new block completed earns less for miners than before.
As a result, the supply of bitcoin is perfectly inelastic. “An increase in demand cannot lead to an increase in the supply of bitcoin or increase the speed at which bitcoin is issued”, wrote Ria Bhutoria, former research director for Fidelity Digital Assets.
Bitcoin’s value is also derived from its decentralized network. There is no central authority with the power to intervene in the bitcoin market.
“No central bank or government can intervene to support or support the markets and artificially control volatility,” Bhutoria continued. “Bitcoin’s volatility is a trade-off for a market without distortion.”
In addition, bitcoin is still very new.
“[It’s] is only 13 years old and therefore doesn’t have much trading history, ”explained Peter Boockvar, Chief Investment Officer at Bleakley Advisory Group. “While a company that went public yesterday in an IPO has no history, a company can at least be evaluated on its business prospects, its results and its cash flow. “
Because bitcoin is still a nascent asset class, it remains in the price discovery phase. “[It’s] the most volatile in the lifecycle of any asset, ”said Mike Bucella, general partner of Blocktower Capital.
“Bitcoin has clearly established itself as a new form of value, but the terminal value is still not defined,” Bucella continued. “This lack of information lends itself to a momentum, or a technically driven market, in the absence of new information.”
The path to true price discovery is often strewn with seismic price swings, but Bhutoria points out that the alternative is artificial stability, which can lead to market distortions that can collapse without intervention.
Get used to it
Bucella believes that today’s trade volatility will repeat itself.
“There will be many periods as we saw today where a cycle of negative news has removed technical levels (and momentum) from the price of BTC – and these are all the more exacerbated when market players are starting to gain leverage, “Bucella continued.
What happened today is fairly typical: the spot sale breaks a key level and the leverage is liquidated, creating a more dramatic sale than the market would otherwise indicate. Bucella says it’s been the same pattern, time and time again, over the past decade, and he believes it will stay that way until we reach a level of mature adoption.
Ultimately, “high risk, high reward” tends to be the rule of investing, and this is especially true for bitcoin.
“All investments come with risk, and just like stocks, crypto is subject to price fluctuations,” said Noah Perlman, chief operating officer of Gemini. “Bitcoin is still a young asset class, but it’s one of the best performers of the past decade.”
Playing the long game is crucial. “As with any market, crypto investors with a longer time frame and a diverse portfolio will see more consistent results,” said Greenspan.
Bitcoin’s volatility also has a sort of “halo effect” on companies exposed to cryptocurrency.
Tesla, which has a $ 1.5 billion stake in bitcoin, fell about 2.5% on Wednesday. Microstrategy, another company that holds a large amount of bitcoin for its corporate treasury, ended the day down 6.6%, and Coinbase, the new public crypto exchange that specifically warned in its S-1 that it was vulnerable to volatile movements in the price of cryptocurrencies, fell 6%.
But for Bucella, this kind of volatility is a gift that most fund managers in traditional markets would salivate. “As a fund manager, with the right risk management, infrastructure and tools, this level of volatility presents huge opportunities,” Bucella said.
Whatever your tolerance for risk, experts say volatility won’t always be so bad.
Bitcoin trading is no longer dominated by retail buyers. Professional fund managers and American companies have flooded the market over the past year, and they are still starting. As more institutional investors embrace bitcoin, it gives cryptocurrency new legitimacy, helping to erase its reputational risk. It also creates more stability overall.
“With greater adoption of bitcoin and the development of derivatives and investment products, bitcoin’s volatility may continue to decline, as it always has,” noted Bhutoria.
And as longtime investor Bill Miller pointed out in a CNBC interview earlier this year, “One of the cool things about bitcoin is that it becomes less risky the higher it goes.”