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Why is Bitcoin’s price so volatile?

Luno Team
4 minute read

Bitcoin's price is notoriously volatile. Over the years, we’ve witnessed huge swings (both up and down) in the span of days, hours and even minutes. But what causes this? Is Bitcoin itself just a bit fickle?

Sparkle

We know that the more volatile the price of an investment is, the more risk you take on by putting your money in it (and the higher returns you potentially stand to gain).

This is no different for Bitcoin.

Over time, 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. The market is still relatively small, so this is a considerably reasonable rate; and not that variant to gold and most major currencies (which have far larger, more mature markets).

Let’s delve into the 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 an obvious public sign 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. Bitcoin was illiquid until recently

There’s only 21 million Bitcoin available and not all have been mined yet.

Much of the available Bitcoin is held by a few people. It’s estimated that 4% own 95% of the available Bitcoin and 1% own half. The result is limited liquidity.

Liquidity refers to how easy it is to buy or sell something, without changing its price.

When there’s not much liquidity, that means only a few people are willing to sell or a few are willing to buy. This was the case for cryptocurrencies in the past.

Many of the largest Bitcoin holders were unwilling to sell under any circumstances. So if someone tried to buy a lot of Bitcoin at once, there wouldn’t be enough available. This would push the price up until more people sold.

The same happens in reverse. If a lot of people decide they want to sell their Bitcoin at the same time, there might not be enough buyers. Prices might then drop, until the lower price attracts more buyers.

Once again, that’s changing. More people than ever are buying and selling Bitcoin, so there’s more liquidity in the market. This helps to even out prices.

3. 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.

They 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 then 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.

4. Bitcoin price is sensitive to the news

Buy the rumour, sell the news.

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:

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. Try not let strong emotions get the better of you. Doing your own research, 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 open the side menu in the app, tap ‘PRICE ALERTS’ and decide when you want to be notified.

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Luno Team

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