As a long-time technology investor and speculator, I like to think that my risk tolerance is pretty high, but even by my standards, the leaps and lurches of prices in the crypto market can be shocking. It goes without saying, but if the stock market performed like this, there would be far fewer pension funds investing in it. So what is going on to cause this price volatility?
The first thing to note is that volatility goes both ways: up and down. If prices are rising quickly, that is a sign of volatility. Most of us are following a simple buy and hold strategy. In those circumstances we like to see the price rise, but sharp upward moves in the cryptocurrency market are volatility as well. When you consider this, cryptocurrency volatility seems to be high virtually every day of the year.
There are a number of factors unique to cryptocurrency which either create or amplify this volatility.
Firstly, the entire crypto space is still very new and a very young technology. If you are reading this in early 2021, soon after publication, then you can be sure that you are still “early” in crypto. Money flows into and out of crypto very quickly. Emotional sentiment is very powerful and confidence ebbs and flows.
As we have seen, Mark Cuban and Elon Musk are moving the market with tweets and comments this cycle. Last time around it was John McAfee and Craig Wright. Every famous person in finance has an opinion about Bitcoin. Their diversity provides entertainment and a lot of comment in the media. In a relatively small, thin market — which crypto still is — that can be a powerful driver of prices.
In such a young and fast moving space, there are inevitable hiccups and problems. In crypto, those problems include hacks and losses. We have protocols that lose funds through code errors, protocols and exchanges that lose funds through hacks and when your history includes the words “Mt Gox,” well, enough said. Each hack is a slight knock in confidence in the entire crypto space and they usually move prices for the entire market when announced, or discovered.
It is also worth noting that crypto is truly global and 24/7. This means that there are news announcements and statements from politicians that can move a market in a far away country. If you are reading this in North America, then it is only a matter of time until someone powerful in Asia says something that moves the market dramatically while you are sleeping and the only news you can find is in Japanese or Chinese. Even if it does not actually add to price volatility, it certainly feels as though it does!
Time and geography are extra dimensions in crypto when compared to stock market prices, because stock exchanges have opening and closing times, weekends and bank holidays off in a way that crypto does not. Crypto is the world of internet money set on fast forwards.
Why Is Bitcoin So Volatile?
One of the many strengths of Bitcoin is its total fixed issuance of 21 million coins. However, to get there, the regular halvings will continue to create supply and demand imbalances for decades to come. Those imbalances are very likely to continue to have a dramatic impact on price.
The impact of this process is amplified in the market by the sheer size of Bitcoin relative to everything else. As long as Bitcoin retains a position as the largest cryptocurrency, its halving will have a direct impact on the overall direction of the market.
This is further amplified by other important coins that are forks of Bitcoin and have their own halvings. For example, Litecoin, Bitcoin Cash, Bitcoin SV and Zcash each have their own halving schedules, most of which will continue to fall at similar times to that of Bitcoin. In addition to this, there are other coins — Dash, Monero and soon Ethereum, come to mind — that have issuance that will continue to reduce every year. Their impact on the market will be smaller, but it all adds up to very real limits on available supply.
It is also worth considering the impact of major holdings and whales in the market. We have all read about Bitcoin OGs that hold thousands of coins; now we can start adding funds like Grayscale to that list. As they gobble up the available supply, less and less free float is available for the rest of the world to trade in. When supply is tight and demand surging, the price will only go one way!
Will Cryptocurrency Volatility Ever Reduce?
When discussing Bitcoin volatility, the media often writes a variation on, “Experts suggest that the price will become less volatile as Bitcoin grows in size.” Is it true? It is easy to understand why people might think that, after all, moving the price by 10% will be much harder to do when the price of one coin is $200,000. But still, is it true?
So far, the world has not had an asset like Bitcoin to assess how its price will move in the future. The best we can really do is to look at major corporations that are listed on a major stock exchange. Has there ever been a corporation that limits its stock every four years in the way Bitcoin does? No, not to my knowledge. This means that we are in uncharted territory.
The CEOs of mega corporations often pursue stock repurchase programs to limit the available supply of company stock in the market. They do this to try and change the supply and demand and push the price up. This move does not always work, but it often does. This suggests that limiting the new supply of Bitcoin might continue to impact supply and demand every four years.
My personal belief is that these factors will have the opposite effect — they will increase cryptocurrency and Bitcoin volatility even more in the future.