Why Is Bitcoin So Volatile?

By Matthew Zeitlin 

Of all the things Bitcoin is rightfully known for—its range as a payment network, not the security of its protocol, nor the potential for blockchain technology to revolutionize any field that uses a database—there’s one that stands out as it’s most defining feature: its price, and how it goes up.

But the price of Bitcoin doesn’t always go up. To get these screaming vertical price increases, there have to be some bone-chattering falls as well. It’s that volatility that makes Bitcoin a tempting investment to some, and a dangerous one to others.

Bitcoin Price Volatility

There’s no denying, Bitcoin is volatile. In all of 2020, the price of Bitcoin went from around $7,200 to $29,000—a 300% increase. The price of Bitcoin went up 14% in January 2021, and then between Groundhog’s Day and Valentine’s Day it rose 38%.

And there have also been some famous drops in the decade or so since Bitcoin was created. One famous dip occurred in 2017, when Bitcoin’s price dropped 20% November 9 and November 13. More recently, on May 17, 2021, Bitcoin dropped 35% from its high of $64,880 from April 14.

While volatility is basically a given across all different types of cryptocurrency, given the general air of legal, political, institutional technological uncertainty that floats around them, it’s most noticeable with Bitcoin. Not only is Bitcoin the most valuable cryptocurrency, it’s seen as a flagship for the whole space and the one taken most seriously by government, companies, and financial institutions.

Bitcoin is increasingly an investment, speculation tool, and savings vehicle for millions of everyday people. But before investing in cryptocurrency like Bitcoin or any other type of cryptocurrency, a smart investor may want to seriously consider its volatility.

Why Does Volatility Matter?

There’s a reason that nearly anyone well-versed in cryptocurrency will caution novice investors to invest no more than you’re willing to lose. With a highly volatile asset like Bitcoin, an investor’s overall portfolio value could suddenly shoot much higher or much lower than they expect or are prepared for based on big changes in its price.

Why is Bitcoin so Volatile?

Bitcoin isn’t the only asset with unclear “intrinsic value” to see big price swings, that lead, overall, to large price increases. Let alone other cryptocurrencies, including more established ones like Ethereum and literal jokes (no, really!) like Dogecoin.

There are a few reasons why Bitcoin’s price is so unstable.

Liquidity

Liquidity is a concept in financial markets that relates how much a given purchase or sale of an asset will move its overall price. Liquidity, in general, supports overall asset values. If you have something with a price of $500 but when you need to sell it, there’s no one to buy it, the $500 it’s worth isn’t worth that much. Low liquidity may be rendering the price of Bitcoin unstable.

One concern with Bitcoin is that a huge portion of all the Bitcoin circulating in the world (over 18.5 million, with a grand total of 21 million that will ever be mined) is not going to be bought or sold by anyone. This could be because it’s stranded in wallets for which the private keys have been forgotten or because they’re held by investors who will never sell, no matter the price.

By shrinking the amount of Bitcoin in circulation beyond the limits built into the system, liquidity for Bitcoin can dry up. This means that movements to buy or sell could quickly influence the price, driving it up or down violently.

Speculation

One of the biggest debates regarding Bitcoin and cryptocurrency is what exactly it’s for—and why people are buying it. For individuals who live in countries with unstable or despotic governments, Bitcoin can be a lifeline of stable value and resistance to seizure, but for many people, it is not an especially convenient payment mechanism compared to fiat currency of existing banking systems.

And yet many people are buying Bitcoin and willing to pay ever-higher prices for it. The main reason seems to be that they expect the price to get even higher in time. Some people think the price will go up because Bitcoin is uniquely protected against inflation due to its 21 million coin cap. Some expect wider adoption of it as a payment protocol. And some expect it to become a widely used store of value for institutions that generate large amounts of cash.

Essentially, interest in Bitcoin is generated by the idea that other people are going to buy in the future, at a higher price than it’s selling for today. This expectation is fed by near-daily headlines about a company or celebrity buying into Bitcoin and the massive profits people are generating from Bitcoin they bought years—or even weeks—ago. Speculation like this often leads to volatility, because the price can turn down as sharply as it turns up.

Analysts have said that it’s precisely the speculative nature of Bitcoin that right now that puts it at risk of falling from its current high prices. If a big portion of the buyers are largely trying to get in front of buyers that will come in later, an asset’s price is likely to swing. That’s because the buyers who are eager to buy immediately may quickly dump the asset if they’ve made a quick profit or no longer think the cavalry will come in and buy up what they’ve just bought into.

The Takeaway

Bitcoin’s volatility can be tied to a few things—its potential low liquidity, and the highly speculative nature of this cryptocurrency. As a result, investors and anyone who follows the news are aware of shocking highs and lows in the value of this well-known crypto.

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