What Makes Bitcoin So Volatile?

Bitcoin’s Rise

Earlier in 2021, Bitcoin hit its all-time high at over $64,000 USD per coin. Hard to believe that in 2008, the price of one Bitcoin was $0.0008. While it had a strong internet community even back then, it took awhile to gain traction. In 2010, the price went up to a whopping $0.08, exciting early investors, like Tyler Winklevoss and Dan Morehead.

May 22, 2010, became immortalized as Bitcoin Pizza Day. Laszlo Hanyecz paid 10,000 Bitcoins for 2 Papa John’s pizzas. A man in Britain agreed to order two pizzas in exchange for these Bitcoins. In March 2021, these 10 000 Bitcoins are worth more than 300 000 000 USD. This may have gone down as the greatest trade ever made.

Over the next several years, Bitcoin would continue to skyrocket. Sure, there would be many crashes and price corrections along the way. Nonetheless, its price continued to grow year after year.

Early Investors Who Got Rich Investing in Bitcoin

Cameron and Tyler Winklevoss were early investors in the cryptocurrency, helping them become billionaires. Even as Bitcoin is valued at more than $30,000 USD, Tyler still believes it is an incredible investment:

“We still think it’s really early. We think bitcoin is gold 2.0. It will disrupt gold so its market cap has to be $10 trillion or more, because that’s the market cap of gold. Bitcoin is hovering around $1 trillion, we think conservatively it’s at least a 10x from here. Even at $35,000 it feels like a really good buying opportunity long-term.”

Dan Morehead founded Pantera Capital in 2013, around the time that Bitcoin was worth $65. Focusing on Bitcoin, his fund has provided a 24,000% return to investors to date. In 2020, he told Reuters:

“I realize that price may sound ludicrous to some today. But $5,000 sounded equally ludicrous as our first written price forecast when we launched Pantera Bitcoin Fund at $65 per bitcoin, just saying that there’s more than a 50-50 chance bitcoin goes up – and goes up big.”

[insert diagram of bitcoin timeline]

Bitcoins opened the door for many other cryptocurrency and Blockchain networks. Even more important, it got regular people interested in cryptography, technology, and finance.

Inflation

It also has a built-in hedge against inflation. This protects you from the devaluation of a currency as the prices of sales and goods increase. For example, during the financial crisis in 2008, many Americans went bankrupt as inflation doubled. That’s why inflation protection is good for you and me.

Only 21 000 000 total coins would ever be issued. This is extremely appealing to people with a distrust of traditional financial systems. In some countries, issuing more and more currency leads to vast levels of inflation, Hungary and Zimbabwe being the famous ones. Bitcoin, at least, would not follow this same fate.

As proof that inflation (and the devaluation of Bitcoin) has been avoided, year after year, consistently, the value of Bitcoin has increased. There is only one year its price decreased at the end of the year, compared to the start of the year. At the end of 2018, Bitcoin was worth more than 3000 USD. Despite the price plummeting here and there, it rose to more than 60 000 USD this year.

Some predictions believe the price may hit 100 000 USD or higher, it’s value only increasing – not decreasing. Wouldn’t we all want to be paid in bitcoin?

Who is Getting Into Bitcoin?

With more traditional financial institutions getting into cryptocurrency, maybe the sky’s the limit. There are two dozen companies with public Bitcoin holdings, including Microstrategy, Tesla, and Square. Institutions including Goldman Sachs and many U.S. banks recognize Bitcoin as an important asset and offer investment opportunities to their clients.

June 9th 2021, El Salvador announced Bitcoin would be accepted in the country as legal tender starting in September. It would allow people living abroad to extremely easily transfer money to their families and fuel job growth.

El Salvador is hoping to leverage the geothermal energy of nearby volcanoes to mine Bitcoin, too. Many investors there hope the price of Bitcoin will bubble up and erupt once more, when the facility is completed.

This shift means that prices in stores and shops could soon be listed in Bitcoin. Maybe in El Salvador, you’ll eventually be paid in Bitcoin. Citizens will also be able to pay taxes using cryptocurrency.

Who Isn’t Getting Into Bitcoin?

Many countries have attempted to ban Bitcoin, unsuccessfully in most cases. China and India are actively getting out of Bitcoin. In 2013, China began its crusade against the cryptocurrency, barring banks from handling Bitcoin transactions.  In 2017, they banned initial coin offerings, preventing groups developing cryptocurrency and Bitcoin applications from raising capital. In 2021, China looked to ban Bitcoin mining operations in the country. Since China was one of the world’s major hubs for Bitcoin mining, this announcement drove down the price of Bitcoin. It would not be surprising to see Bitcoin and other cryptocurrencies completely outlawed in the future.

In March, reporting revealed that India intended to ban ownership of cryptocurrency through sweeping regulation. The country previously banned banking institutions from dealing with cryptocurrency, but this was overturned by their Supreme Court.

In response to energy blackouts, Iran passed a ban on mining Bitcoin during the summer months. Their mining rigs account for 3.5 – 4.5% of the network’s total capacity.

Bitcoin’s Value

Like many other stocks and assets, a lot of Bitcoin’s value comes down to psychology and opinion. Really, what determines the value of anything? Why are certain Air Jordans considered so valuable? Why are some Magic the Gathering cards insanely valuable? Why is a Mona Lisa painting worth more than almost all other art?

They are valuable because there is an intricate relationship between the supply of an asset and how much people want it.

Now unlike other asset classes, the price of Bitcoin isn’t tied to anything physical or tangible (like gold or silver). Its value is intrinsic, just like a Pokemon card. Unlike Fiat, there is no centralized authority deciding how much Bitcoin to issue, to tackle financial bubbles. Instead, inflation is controlled through the limited supply of available Bitcoin. Thus, individual traders play an important role in deciding the value of Bitcoin.

An asset is only worth as much as people are willing to pay for it. In this sense, the technology behind Bitcoin, the blockchain, is a huge draw. Whenever Bitcoin is adopted or endorsed by large financial institutions, companies, countries, or even celebrities, the price gets a bump. But this can also send the price plummeting quickly. A large selloff or ban (like in China, or Turkey) can lead to drastic declines in price.

Bitcoin Offers An Alternative to Central Banks and Institutions

Bitcoin has a unique appeal based on its technology and use cases. It is a viable alternative to banks, allowing us to avoid institutional investors. One reason it has risen is because of the distrust in large banking institutions, and the stock market. This has forced those who are harmed by the world’s financial system to develop alternative financial models.

Much of the world’s population do not have easy access to a bank account. In Morocco, Vietnam, Egypt, Philippines, Mexico and Nigeria, more than 3 in 5 people don’t have a bank account. Monetary inflation has increased worldwide, in part through central banking institutions and the credit industry.

During financial crises, banks remained while individual retail investors lost their money. Bitcoin provides a democratized monetary model appealed to many of these disenfranchised individuals. Plus they have much easier access to the cryptocurrency market, than a bank account. You can legitimately start as a crypto investor with one dollar. On top of that, getting your money out, (i.e. liquidity) is much easier than a bank.

Secure Transactions

Bitcoin and Ethereum provides secure Peer-to-peer transactions, making it easy to transfer  your digital assets  between people living across different continents. There is no need for another institution or central authority to facilitate this transfer and take a cut of it, or slow it down. It is also cryptographically secure and extremely challenging/expensive to defraud.

The trustless nature of blockchain technology makes it a great alternative to the current banking system. Meanwhile, banks are still too susceptible to fraudulent transactions, costing people millions of dollars every year. Many of these schemes lead to embarrassment, making it unlikely that the fraud would be exposed.

The Chaotic Nature of Bitcoin Prices

The downside is that external events, not intrinsic value, also derail the price of Bitcoin. A lot of people who enter this space do so to make quick money. Many people see it as a vehicle for wealth after seeing the price go up. Memes on Reddit, Twitter, and Facebook may encourage otherwise unseasoned investors into making the dive. Since they haven’t been exposed to the space, new investors are susceptible to making mistakes.

When they see that the price of Bitcoin drops a little bit, they sell at a small loss. When a lot of people sell their Bitcoin, Ether, or other asset, the community can take notice. This reaction can snowball leading to many newer investors getting cold feet, and selling off their cryptocurrency.

The March 2020 Bitcoin Price Dip

Amidst the COVID-19 pandemic, Bitcoin’s price dropped in March 2020. The price fell from more than $10,000 to below $3600 USD yet it rallied back, surpassing the $10,000 USD mark by October. This is another example of the volatility bitcoin investors can expect, at least for now, when it comes to Bitcoin.

However, there is a method behind the madness. The price dropped as many Bitcoins were being liquidated, leading to the sell-off. On one platform called BitMEX, users could borrow extra money beyond their deposit to invest into Bitcoin, up to a 100:1 ratio. The price on this exchange was much lower than on other exchanges. People began to sell-off their holdings to avoid incurring further losses. Since transactions take some time to go through, it caused a backlog.

While we can’t predict the way the price will go on a given day, we can look at overall trends. It’s like the weather – we can’t predict it day-to-day but we have a good idea of climate trends. With climate change, scientists can predict that our global temperature will continue to rise. We can say the same for the price of Bitcoin.

Government Conflict

Due to its cryptographic properties, Bitcoin users are afforded a certain level of privacy. Whenever this comes into conflict with the monetary policy, or financial markets, of an economically powerful country like the USA or China, new laws are considered or enacted. Restrictive laws can then drive the price down. On the other hand, news of Bitcoin adoption by traditional financial investors and countries makes people more confident in the asset.

Twitter

Another problem is that someone with a large following on Twitter can influence the market through Twitter. Elon Musk, probably more than anyone else on Twitter, has had a huge impact on Bitcoin. Here’s a few recent examples.

Volatility as a Feature

Since there isn’t an external source for its value, it will have  a high volatility . Consider large drops in price and sell-offs as a market correction rather than an actual plummet. Remember, historically, the value of Bitcoin continues to increase despite any technical or legal barriers, so the price swings can be considered a feature

The Role of Narrative in Economics

Narrative has also always played a role in economics. Other traditional financial companies also sell their narrative along with their product, hoping to prevent price volatility. It’s clear from Elon Musk’s ventures that narrative and memes play a strong role in the economic space. In fact, without it, Bitcoin wouldn’t be nearly as strong.

Unlike real estate, the price will come down every once in a while allowing us ‘retail investors’ continual opportunities to get on board.

History / Memes

Cryptocurrencies, especially Bitcoin, may be the greatest asset class in history. Will all cryptocurrencies survive 10 or 15 years down the line? Probably not. But Bitcoin is poised to remain an important part of this ecosystem.

Berkshire Hathaway is another company fuelled by memetic narratives. Before Elon Musk, Warren Buffett was the self-made investor and billionaire. Before memes gained their popularity, Buffett had many quotes that spread around the investment space, building his legend. The memes behind Bitcoin may be sufficient to keep it alive, even ten years from now. We may view them the same way we view Warren Buffett quotes.

“Honesty is a very expensive gift. Don’t expect it from cheap people.”

“Price is what you pay. Value is what you get.”

“Rule No. 1 : Never lose money. Rule No. 2 : Never forget Rule No. 1.”

“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”

Bitcoin is a Valuable Investment

Many companies like Amazon and PayPal have high valuations because investors believe in them. Similarly, there is a strong belief in Bitcoin’s technology from both retail investors as well as larger institutions. It’s volatility also drives its value as an investment.

Here is a short-list of companies and applications integrating Bitcoin into their finances:

• Goldman Sachs partners with an investment firm to sell Bitcoin futures
• Tesla buys 1.5 billion USD in Bitcoin
• El Salvador will introduce Bitcoin as legal tender
• Square invests 5 million into wind-powered Bitcoin mining
• Square also bought 170 million USD in Bitcoin

While many people dip in and out of Bitcoin, many more are long-term crypto market investors. Many people allocate 5-10% of their investment portfolio to cryptocurrencies. As a multi-year investment, Bitcoin provides you with a lot of value if you can stomach the ride, unlike traditional markets or the U.S. Dollar. There you are asked to put your money in and wait, for decades. In the crypto community, we say HODL (hold on for dear life). HOLDing means that crypto traders  stay calm when the price dips, riding out your investment. 

After every stellar rise, Bitcoin experiences a market correction. If you want to make a healthy profit, you can sell some of your holdings, through a cryptocurrency exchange, at the top or at least on the way up. You can also reinvest during the next dip or market correction.

At the earliest sign of a Bitcoin price dip, people get scared and start selling off their investments. However, Bitcoin has always recovered from this market correction, with long-term holders and investors benefiting the most. If you can afford it, Bitcoin is worth buying when its price plummets.

Finally, do not panic and sell your Bitcoin when the price of cryptocurrencies drop. Stay with your investment, stay away from social media and keep your cool. Bitcoin has gone up each and every year so far, including last year. It is more than likely that the price will rise, at which point you can receive a nice return on your investment.

Takeaways

The volatility of Bitcoin is a feature and not a bug of this monetary system. It means that the value is truly intrinsic and decentralized. Without the backing of a government, Bitcoin’s price truly depends on how we use and perceive it. The volatility is also what can make investors rich. Buying in when the price drops, as opposed to the all-time highs, is an almost sure-fire way to make a return on your investment. 

Yes, this makes it a lot more chaotic than traditional Fiat currencies and investments. Bitcoin could plummet 10% one day and rise 10% the next day. There are a lot of uncertainties when it comes to Bitcoin regulation and its dominance in the cryptocurrency space moving forward. 

Nonetheless, the narrative behind Bitcoin is strong enough to drive a core community that believes in its value. Bitcoin doesn’t offer any products or services. So it relies heavily on this belief and its utility as an investment vehicle. 

Bitcoin itself is the product introducing a lot of monetary volatility for retail investors. Nonetheless, its track record has proven time and time again that it is an excellent store of value. In the future, this asset will gain some pricing stability. Until then, we ride the roller-coaster together. Take advantage of the dips, make some memes and enjoy the ride.