What is Bitcoin Volatility: A Double-Edged Sword
In the investment world, volatility refers to how much an asset’s price fluctuates. Depending on the investor, it can be considered a good thing because it gives them an opportunity to profit by buying low and selling high. But volatility in crypto and Bitcoin (BTC) in particular, can be extreme, with asset prices changing very suddenly. In some cases, this leads to huge profits, but in others, it leads to huge losses.
What Is Volatility?
To understand why and how Bitcoin is volatile, we first need to understand volatility. An asset is considered volatile if its price changes aggressively every day. Assets like cryptocurrencies and stocks are considered volatile, while gold and bonds are generally considered non-volatile because their prices are more stable.
Volatile and non-volatile assets (Source: masterthecrypto.com)
Bitcoin is known for its unrestrained volatility, and this is one reason why new investors are often afraid to dabble in cryptocurrencies. Volatility plays an important role in any market: the higher the volatility, the higher the risk and returns.
If there is very little volatility, investors will neither lose nor gain a lot of money. In the stock market, extreme volatility is rare. In crypto, however, it is very common. These high-volatility events present a good opportunity for investors to sell assets at a price higher than where they bought in.
In Bitcoin, people have lost millions of dollars overnight because of high volatility, but many have also become billionaires because of it. Bitcoin volatility is a double-edged sword that can either win you a substantial amount of money or increase your risk of losing everything. Investing in an asset as volatile as Bitcoin should be done with caution and thorough research.
How Is Market Volatility Measured?
The stock market’s volatility is measured by the Cboe Volatility Index (VIX). A value of anywhere between 12 and 20 is considered low. If an asset’s volatility surpasses 30, it is considered extremely volatile.
Volatility in stocks is more stable than in crypto. For example, the VIX was highly stable between 2004 and 2007, and even when the 2008 financial crisis drove the VIX up to 89.53 in October 2008, it quickly came back down to 22.27 just one year later. After the financial crisis, the VIX saw a long period of stability. However, in 2020 this volatility returned due to the coronavirus pandemic’s implications on the economy.
Is There a Volatility Index for Bitcoin?
Bitcoin’s volatility is measured by the Bitcoin Volatility Index. The index measures Bitcoin’s historical volatility by calculating the “standard deviation of daily returns for the preceding 30 and 60-day windows.”
In June 2021, when Bitcoin’s price fell below $30,000, its 30-day and 60-day volatility index values reached their highest points since April 2020. There are no official thresholds for determining what counts as “extreme,” but one only needs to look at Bitcoin’s chart for the past 10 years to know that it has not enjoyed as much stability as stocks.
30-days Volatility Index (source: Phemex)
Why Is Bitcoin So Volatile?
From October 2017 to January 2018, Bitcoin’s volatility reached 8%, twice that of the volatility it reached in early 2020. In April 2021, Bitcoin was trading at $65,000. But in July, after China announced a crackdown on mining farms and Elon Musk deemed Bitcoin’s environmental impact harmful, its price plunged below $30,000.
To better understand why Bitcoin’s price fluctuates and what drives its volatility, let’s look at the following factors:
- Limited regulation: Unlike other markets, crypto markets have no central authority that can interfere when volatility becomes too high. Without targeted anti-market manipulation laws, it’s also easier for manipulators to run schemes that contribute to high volatility.There are some anti-fraud laws in place that can prevent market manipulation, but it is difficult to track people who run and participate in pump and dump schemes through messaging groups.
- News events: Simply put, bad news makes Bitcoin’s price fall, and good news makes the price rise. For example, when Elon Musk tweeted that Tesla was no longer going to accept Bitcoin as payment, Bitcoin’s price fell by 10%. When Tesla announced that it would resume Bitcoin transactionsonce BTC is mined with cleaner energy, the price went back up by 9.60%.Many Bitcoin investors base their decisions on crypto-related news. When they hear something good about Bitcoin and see that the price is going up, they experience FOMO and decide to invest.
- Public perception and speculation: Many people say that Bitcoin has no intrinsic value, instead, it derives its value from people’s trust. Therefore, public perception is important. As a decentralized currency, Bitcoin’s value is driven by speculation. Unlike the stock market, where you buy shares of a company based on its performance, most people invest in Bitcoin because they hope its price will go up in the future, without understanding the technology behind it. This leads to a lot of guessing and speculation. Stocks generate dividends, and people who invest in them know that they will get their investment back, but with Bitcoin, there are no dividends and there is no guarantee that investors will get a return on their investment. When people lose faith in Bitcoin, its price can plummet.Bitcoin investment is all about making good guesses. If you predict the price will go up and you buy before it actually does, you will make a profit. You will also make a profit if you short sell Bitcoin and the price goes down. These speculation-based bets make Bitcoin extremely volatile.
What Major Events Have Contributed to Bitcoin’s Volatility?
As mentioned above, news events can have a significant impact on Bitcoin’s price. Events such as hacking of crypto exchanges and the proposal of new laws regarding Bitcoin regulation can both move its price up or down very quickly.
In 2013, for example, China banned Bitcoin transactions, which caused its price to crash from around $1,200 to $840. In 2016, when former Bitcoin Core developer Mike Hearn declared Bitcoin dead and left the community, Bitcoin’s price fell from around $400 to $360. After a few months, it overcame this drop and reached an all-time high of $1,220.
More recently, after U.S. President Joe Biden announced that his administration would double taxes on capital gains for people making more than $1 million, Bitcoin’s price fell 5% to $48,886. This was the first time since March that it had fallen below $50,000.
Perhaps this will change when Bitcoin becomes more widely accepted around the world, but for now, aggressive news-driven price changes are very common.
How Can I Profit from Bitcoin’s Volatility?
High volatility may seem daunting if you are new to crypto, but most people agree that it is not a bad thing. You can profit massively from Bitcoin volatility if you have a solid strategy.
Short and Long Bitcoin
Most people prefer a less-risky long-term approach (buying and holding until Bitcoin’s price has gone up significantly), but many also use short-term approaches to make quick profits. In short-term trading, predicting price movements is challenging. When a price declines dramatically, it can lead to FOMO, causing people to sell their coins and lose money as a result. If you are able to accurately predict Bitcoin’s price, then you can make a lot more money with short-term investments than a buy and hold strategy.
In any case, you’ll want to diversify your investments. If you invest only in Bitcoin, your entire portfolio is vulnerable to any price crashes Bitcoin may experience.
Who Should Be Wary of Bitcoin’s Volatility?
Bitcoin’s high volatility is not for everyone. If you have a high-risk tolerance, it makes sense to invest in Bitcoin and consider its high volatility an advantage. But older investors with less risk tolerance may find it more suitable to invest in less-volatile assets like bonds.
In addition, many businesses find it too risky to accept Bitcoin as payment, because they have to convert BTC into their local currencies. Bitcoin’s price can change significantly between the time it’s accepted by a business and the time it’s converted into local currency. By the time it’s converted, it might be worth much more or much less in the local currency than when it was accepted. Many businesses can’t accept this unpredictability.
Bitcoin’s high volatility is a major factor driving its continuously growing popularity. But while it has helped people make substantial returns on their investments, it has also wiped out some investors’ life savings. Bitcoin’s price can easily experience wild swings in a short period, and this makes it a risky investment, mainly suiting investors with higher risk tolerance.
Can Bitcoin overcome its volatility problem?
Compared to stocks and other securities, Bitcoin is still new, and it is a digital asset. As it becomes more widely accepted with time, its volatility may decrease. Low volatility would take away many quick-profit opportunities from traders, but would also make Bitcoin more attractive to institutional investors as a safer investment similar to stocks.