There is nothing like a fast rising price for bitcoin or a sudden price drop to get the whole cryptocurrency space back into the spotlight. Regardless of whether you’re looking at the way the price of bitcoin is increasing rapidly or decreasing rapidly, there’s really no question — Volatility in the market tends to draw in both old timers (experienced traders) and newbies alike. And, it’s when people start asking themselves questions like “can I use PayPal to buy bitcoin?” because they want to find simple ways to enter into this market.
But, prior to getting caught up in how to purchase your own digital assets, let’s take a closer look at why the price of bitcoin is moving so wildly right now and some of the current drivers influencing the latest market moves. Unlike many traditional financial instruments, bitcoin operates in real-time — i.e., 24/7. Therefore, unlike many traditional financial instruments, it is open to an international pool of investors. Furthermore, it is impacted by a totally unique mix of economic, technological and market specific influences. So, large price swings in bitcoin are completely normal; they’re actually a natural part of how this very young asset class functions.
What Volatility Means
Volatility is simply defined as the amount that an asset’s price changes over a given time frame. In general terms, low Volatility equates to an asset having relatively minor day-to-day price changes whereas high Volatility equates to the possibility of substantial percent changes in the price of an asset taking place in just a matter of hours.
Historically, bitcoin has exhibited a significantly higher degree of Volatility than many traditional investment vehicles. While bitcoin’s historical price fluctuations have decreased somewhat as the market matures and grows, substantial price swings remain common.
Why Bitcoin Is Inherently Volatile
A variety of attributes lend to bitcoin’s inherent Volatility. A primary factor contributing to bitcoin’s Volatility is its fixed supply. Additionally, since bitcoin operates 24/7, it does not have closing times similar to stocks and commodities. Lastly, a diverse group of individuals utilize the blockchain platform. Some individuals view it as a long-term store of wealth, while other individuals are speculating on short-term price swings. Such conflicting views naturally cause periods of increased buying and selling pressure.
Macroeconomic developments are influencing bitcoin more than ever
Over the last few years, macroeconomic trends have become a progressively larger influence on determining where the cryptocurrency market goes.
Decisions related to interest rates, inflation reports, jobless claims and statements made by central banks can all be used to determine how investors feel about investing. If borrowing costs become more expensive or if investors’ perception of future economic instability grows, investors may choose to de-risk and pull out of riskier assets. Conversely, investors may begin to invest more heavily in the stock and bond markets when investors perceive that interest rates will come down or when investors believe that market liquidity will improve.
Even though bitcoin exhibits characteristics that make it distinct from other traditional financial assets, it still reacts to broader macro-economic trends affecting the global investment community.
Institutional participation has significantly altered the way that the bitcoin market functions
Perhaps one of the largest distinctions between today’s bitcoin market and earlier iterations of the bitcoin cycle is the level of institutional involvement in today’s market. Institutional investors, investment firms, publically traded corporations and financial institutions currently represent a substantially larger portion of total trading volume than they represented in earlier cycles. Decisions made by institutional players can clearly impact trading volume and market liquidity — especially in uncertain economic environments.
For the most part, institutional players react based upon the broader portfolios they manage — not solely based upon crypto-specific Events. Thusly, during periods characterized by either strong investor confidence or heightened risk aversion, bitcoin may move in conjunction with other financial markets.
Although institutional involvement has brought more sophistication and maturity to the market — Volatility has not disappeared.
Supply & demand remain the primary drivers of bitcoin prices
Ultimately, bitcoin’s prices are driven by two fundamental concepts – supply & demand. Supply is quite straight-forward. Only 21 million bitcoins exist. They are created according to a pre-determined schedule.
However, demand is dynamic — subject to constant change due to an array of variables including news Events, government regulations, technological advancements, investor sentiment and market perceptions. When demand exceeds supply for any particular time-frame — prices typically increase. When sellers outweigh buyers during any particular time-frame — prices decrease.
Understanding the ebb-and-flow of these dynamics provides insight into why seemingly small sentiment changes can yield extremely large price swings.
Derivative products often exacerbate price movements
Buying/selling spot prices constitute merely one aspect of today’s bitcoin marketplace. Many professionals utilizing the blockchain utilize derivative products (such as futures/perpetual contracts) to either bet on future price movements or hedge current exposures. Derivative products usually include leverage — allowing users to control larger exposures using lesser amounts of capital.
Utilizing leverage can potentially amplify profits. Utilizing leverage can also exponentially multiply losses.
When markets move adversely against levered positions — automatic liquidation of said positions can occur. Said automatic closure of positions can create further buying or selling pressures — ultimately leading to further accelerated price movements.
That is one reason why bitcoin sometimes experiences massive price swings absent any notable contemporaneous headline.
Sentiment can shift rapidly
Investors do not only react to information (data). Investors also react to expectations. Optimistic headlines can inspire buying even before true adoption begins. Conversely — pessimistic headlines can provoke selling even before true damage is done to bitcoin itself.
Opinions expressed via social media — analysts’ recommendations — economic forecasts — and news coverage all help shape investor sentiment. During bull runs — investors often focus on things such as adoption — innovation — and long-term appreciation potential. During bear runs — investors often focus on issues relating to regulation — security breaches — and/or macro-economic uncertainty.
Since investor sentiment can shift rapidly — experienced market participants often rely on numerous metrics instead of simply reacting to individual news articles.
Government regulation will continue to be an important factor
Regulatory changes will continue to play an important role in shaping the cryptocurrency markets globally.
Governing bodies (federal/state governments and financial regulatory agencies) are beginning to introduce clear guidelines for digital currencies. Regulatory changes can directly affect exchanges — payment processors — custodial services — taxation reporting — and institutional participation.
Positive regulatory clarity may provide comfort to businesses and investors encouraging them to adopt digital currencies on a larger scale. Conversely — unanticipated regulatory restrictions or changes to compliance requirements may temporarily erode confidence in the marketplace.
It is also worth noting that regulatory actions do not necessarily translate immediately into price action. Typically markets spend considerable time assessing how new regulations will impact adoption over a longer period.
Different types of investors have different objectives
Not all investors pursue bitcoin with identical objectives.
Some participants are focused on long-term ownership, anticipating that bitcoin will grow in value over many years regardless of price Volatility. Therefore, such investors rarely concern themselves with daily price movement fluctuations.
Conversely — short-term traders continually assess technical indicators — trading volume — support/resistance areas — and macro-economic news in order to capitalize on price fluctuations over a shorter duration.
Both types of investors must acknowledge that neither type of strategy guarantees success. Success for each type of investor depends on an understanding of market risks — disciplined decision-making — and realistic expectations regarding price Volatility.
Recognizing these various viewpoints helps explain why bitcoin can experience rapid price swings even when its long-term fundamentals seem to be relatively stable.
What do investors need to take away from Volatility?
Volatility tends to remind investors that bitcoin represents an evolving asset class. Even though large price swings can present opportunities for investors; they also present substantial risks for participants in the market.
Rather than perceiving Volatility as purely negative; many experienced investors regard Volatility as a characteristic that needs preparation; not forecasting. Experienced investors who understand why prices fluctuate; how different classes of market participants operate; and which external factors influence demand are better positioned to make informed decisions relative to their personal circumstances.
There is no way to predict with certainty the timing or magnitude of bitcoin’s next big price move. A multitude of interrelated factors including economic conditions; investor sentiment; government regulatory development; technological advances; and global financial markets all interact in complex ways making prediction impossible with any degree of accuracy.
Regardless of how well established bitcoin may eventually become; periods of tranquility will be followed by periods of heightened Volatility. For those observing the market, perhaps the greatest benefit derived from understanding the causes underlying price movements is being able to accurately evaluate market positioning; maintain reasonable expectations regarding potential outcomes; perform adequate research regarding potential risks; and develop awareness regarding inherent risks associated with participating in this market.