Jul 31

Understanding the Volatility of Bitcoin: Exploring the Reasons

Bitcoin's reputation for extreme volatility is no secret, often experiencing enormous price shifts within hours. What's the root cause of these drastic changes? This article delves into the factors influencing bitcoin's price swings and considers the risk or reward of buying the dip.

The potential to amass wealth swiftly through bitcoin is tempting, yet within days, significant portions of investments could evaporate. Such is the nature of bitcoin, the inaugural cryptocurrency known for its rapid price ascents and equally swift descents. This article explores the underpinnings of these drastic price changes and considers if volatility is always detrimental.
Understanding Volatility

Volatility signifies the pace at which an asset's price escalates or declines. A highly volatile asset's price can shift considerably in a brief time frame.
Bitcoin, born in 2009, was initially worth merely a tiny fraction of a cent. Approximately a year after its inception, bitcoin gained some traction and reached nine cents. Since then, the premier cryptocurrency has appreciated thousands-fold, accompanied by substantial price fluctuations, thus characterizing it as highly volatile.

Several factors contribute to bitcoin's roller-coaster-like behaviour, and the crypto business at large.

Bitcoin's Relative Novelty and Immaturity

Bitcoin's volatility can largely be attributed to its comparatively nascent status. While bitcoin has been around for just over a decade, traditional asset classes such as stocks have been traded for centuries, proving more stable with fewer price fluctuations. The world is still attempting to comprehend and define the place of cryptocurrency in the global economy.

The sentiment towards bitcoin among investors often oscillates, greatly affecting its price. Reactions range from macroeconomic events like the Federal Reserve's interest rate announcements to commentary by influential figures like Elon Musk. A single news event can shift sentiment from bearish to bullish, and vice versa.
How does sentiment shape a coin's price? The principle is straightforward: positive sentiment increases demand as investors want to acquire more bitcoin, leading to a price rise. Conversely, negative sentiment triggers selling, reducing demand and causing the price to fall.

Crypto Market's Limited Capitalisation

The crypto market is comparatively smaller than other markets. As of April 2023, the total capitalisation of the crypto market just surpassed one trillion dollars, a fraction of the New York Stock Exchange's thirty-five trillion dollars.
Smaller markets tend to be more volatile and risky, often controlled by a handful of large players. Consequently, a couple of 'Bitcoin whales' (entities or wealthy individuals with substantial BTC holdings) can greatly sway Bitcoin's price by buying or selling sizeable amounts.

Influence of Media Hype on Crypto

The media plays a significant role in dictating Bitcoin's volatility. Cryptocurrency, particularly bitcoin, is a common theme in social and mainstream media, with business figures, financial analysts, and even celebrities sharing opinions or endorsing it.
Celebrity endorsements of bitcoin can lead to a surge in purchases by fans, while predictions of a price drop by trusted experts could trigger selling. This is how popularity impacts volatility.
Keep in mind that extensive hype around a specific coin can lead to a sudden demand and price increase, which can be short-lived, resulting in overbuying. Overbought assets invariably start to decline. Remember, don't be swayed by the notion that cryptos will always appreciate - market corrections are inevitable.
Bitcoin's Finite Supply

Bitcoin's limited supply further contributes to its volatility. Bitcoin's creator, Satoshi Nakamoto, capped bitcoin's supply at 21 million, indicating that no more than 21 million coins will ever be in circulation, with the last bitcoin expected to be mined around 2140.
With a fixed supply, any variation in demand significantly affects the price. Limited supply can also induce scarcity fears, thereby increasing demand and potentially driving up the price. Interestingly, this perceived scarcity is one of the reasons experts predict bitcoin's price will continue to increase in the future.

Bitcoin's Lack of Financial Institution Control

The decentralized nature of Bitcoin adds to its volatility. Being decentralized means bitcoin is not regulated by any financial institutions or central authorities that can control its supply, demand, and price. While decentralization initially drew investors towards bitcoin due to its independence, it comes with drawbacks. For example, no central bank or government can intervene to control volatility and stabilize bitcoin or any other digital currency's price.

Attempts by Governments to Regulate Bitcoin

While cryptocurrencies like bitcoin are decentralized, governments frequently attempt to regulate their use, further impacting bitcoin's price and volatility.
When Chinese regulators announced a ban on crypto trading and mining in September 2021, the market reacted almost instantaneously, resulting in a massive sell-off of cryptocurrencies. However, the highly reactive crypto market has demonstrated resilience time and time again. Bolstered by positive news, bitcoin managed to recover, hitting an all-time high of $69,000 months later. At the end of 2022, the U.S. government tightened its hold on the crypto industry, contributing to the current volatility as the market responds to each new governmental directive.
Is Volatility Inherently Negative?

Despite bitcoin's high volatility, due to the reasons outlined above, is volatility intrinsically negative? Certainly not! Large price dips may be unsettling, but many investors view them as opportunities to buy the dip, anticipating better future returns. Confidence in the coin's potential growth is key.
As for bitcoin, many experts predict continued price appreciation. The leading cryptocurrency has survived significant highs and lows, proving its resilience. However, novice crypto investors should exercise caution when considering newer coins as they risk losing their entire investment. Diversifying your portfolio is crucial - don't invest too heavily in one cryptocurrency, even bitcoin. Remember, when starting your crypto journey, don't invest more than you can afford to lose. Start small, then gradually scale up!

Final Thoughts

To summarize, bitcoin's volatility can be attributed to:

• Its status as a relatively new and immature asset, leading to market reactions to virtually all crypto-related news and frequent sentiment changes towards bitcoin.

•The influence of social media hype on its popularity and demand.

• The relatively small size of the crypto market, allowing a few bitcoin whales to cause significant price shifts.

• Bitcoin's limited supply, which can create scarcity and intensify competition for bitcoin ownership.

• The lack of regulation by a central bank or financial institution, rendering the stabilization of its price impossible.

• Ongoing attempts by governments to regulate bitcoin use, causing the market to react to every action.

While high volatility can offer opportunities to buy crypto at lower prices for potentially increased future profits, investors should always consider the risks and invest in reliable, time-tested coins.