Bitcoin's price is notoriously volatile. Over the years, we’ve witnessed huge swings (both up and down) in the space of days, hours, and even minutes. But what causes this? And is volatility really such a bad thing?
We know that the more volatile the price of an investment is, the more risk you take on by putting your money in (and the higher returns you potentially stand to gain).
This is no different for Bitcoin.
Over time though, we’re seeing Bitcoin’s price becoming far less volatile. On average, the daily volatility rate (how much the price changes per day) has been mostly under 5% since 2015. Throughout 2020, the average 7-day volatility has sat comfortably around 3.5%.
Generally, the smaller the market cap an asset has, the more volatile it’ll be. The Bitcoin market is still relatively small, meaning it’s likely to be more affected by everyday buy/sell orders. Currently, Bitcoin’s market cap sits at around $117 billion (USD)*. In comparison, gold’s current market cap is at around $9 trillion (USD). The more established and mature a market is, the less volatile it’s likely to be.
*As of 29 July 2020.
Let’s delve into the most common factors that contribute to these price swings.
1. Bitcoin is still a new technology
Bitcoin is relatively young, having only been around since 2009.
By contrast, the internet has been around since the early 1960s, space travel since 1957 and artificial intelligence since 1956. It takes time for a new technology to evolve and find its place in our lives.
New technologies go through what is known as the hype cycle.
At first, few people know about it or use it. Then, it gradually gains mainstream awareness and suddenly everyone is talking about it. Outlandish claims are made, exaggerations abound and the level of hype becomes ridiculous.
Then reality sets in and the hype calms down. But behind the scenes, the technology continues to improve and becomes a productive part of our lives.
Unlike many new technologies, we have a clear public indicator of where Bitcoin is in the hype cycle: its price. Although the cycle is normal, it’s visible, which makes us more aware of the volatility. Bitcoin is both a new technology and an investment. Investing in Bitcoin is a positive nod to the technology, but it’s still early days.
Bitcoin is still going through that cycle as we all figure out its purpose and how it will add value to our lives. Whatever the price charts say, companies like Luno are working behind the scenes to help its adoption and ensure it matters in the long run.
2. Investing can be emotional
It’s appropriate to suggest that ‘emotions’ shouldn’t be part of the equation when it comes to investing. This, however, isn’t always the case.
When the price of Bitcoin drops, investors tend to experience what has come to be known as FUD: fear, uncertainty and doubt.
Investors fear the price will keep dropping. They are uncertain if it will ever increase again. They doubt themselves for investing in the first place. So they sell their Bitcoin. Often, this wasn’t triggered by a real change in Bitcoin’s value, just by rumours or randomness. Price changes are a normal part of any market.
Similarly, when the price of Bitcoin increases, people experience FOMO: fear of missing out. They fear missing out on a chance to get rich and they expect the price to continue increasing. So they start buying Bitcoin, increasing the demand and increasing the price. This enhances natural fluctuations.
One way to think of this is to imagine you are buying a new laptop. You’ve had your eye on one costing $1000 for a while, but you’re hoping it will go on sale.
If the price gets reduced to $600, you immediately buy it. But that’s not how we always act with investments. Our FOMO might make us buy the laptop when it’s more expensive because we think we might be able to sell it for more. Our FUD might make us sell it when the price is lower because we think it might get even lower.
3. Bitcoin’s price is sensitive to the news and global events
Much like investments in traditional stocks, or foreign currencies, Bitcoin’s price can be affected by the news.
Common news items that affect the price include:
- Articles about new regulation or action from banks and governments
- Statements from well-known figures in tech and investment
- News of hacks or security breaches
- Rumours and incorrect information
Throughout 2020, this couldn’t have been clearer. At the start of the COVID-19 pandemic and startling stimulus commitments from the Federal reserve bank, we saw the effects a speech or monetary policy decisions could have on traditional stock markets and the Bitcoin market.
4. Supply and demand
Bitcoin’s price is largely affected by supply and demand. This works the same way as any other asset – the more demand there is, the more people are willing to pay for it. If there was no demand for Bitcoin, people would be looking to get rid of it for a lower price.
Volatility = opportunity
Despite being relatively volatile, it really all depends on what you compare it to – it’s tricky to draw parallel comparisons since there’s nothing really like Bitcoin out there. Volatility is also not necessarily a negative thing – while it may hinder mainstream retail adoption, for example, it can be extremely beneficial to traders who understand how the market works.
These are just a few of the factors affecting the price swings of cryptocurrencies like Bitcoin. Before making any investment decisions, it’s important to understand what you’re getting into.
The price can change in moments so the value of your investment will change over time, perhaps by a lot. Doing your own research, avoiding acting on emotion, and speaking with financial experts will help you make a more educated decision.
If you want to monitor the price of Bitcoin or Ethereum, you can easily set up price alerts in the Luno app. Simply go to the profile tab in your app and tap on “Price alerts”.