Learn about bitcoin volatility and why the digital currency’s sharp price swings shouldn’t scare long-term investors.

Bitcoin’s volatility is a topic that is readily and regularly covered in the media. Be it skyrocketing prices jumps or jaw-dropping price dumps, media is seemingly documenting Bitcoin’s every move. Consequently, potential investors are constantly confronted with the volatility of Bitcoin, leaving them hesitant to invest in the first place. 

Before dismissing Bitcoin for its volatility though, read this article and find out why it shouldn’t care long-term investors. 

Why is the Price of Bitcoin So Volatile?

At the time of writing (March 2, 2022), Bitcoin has experienced a 35.85% drop since hitting an all-time high of $68,789.63 back on November 10, 2021. Zooming out, the Bitcoin chart also shows that Bitcoin has risen by 65,000% since July 2013.  

Bitcoin is famously known for its high volatility, experiencing price movements of several thousands of dollars in either direction. From an investor’s point of view, this volatility resembles a roller coaster ride consisting of adrenaline-inducing highs as well as depressing lows. 

However, understanding what causes this price volatility can help investors remain calm when prices fluctuate. Even more so, knowing where price volatility comes from can help them predict potential price corrections, allowing them to prepare accordingly. 

It’s Supply and Demand, stupid! 

Simply put, Bitcoin’s volatility is a function of supply and demand. With a supply cap of 21 million coins, the cryptocurrency is a scarce resource by design. Therefore, as supply decreases, the price is likely to rise over the long haul, given that demand remains high. 

This is simple economics that states that a high demand coupled with limited supply results in higher prices. For instance, during Q1 of 2021, Bitcoin was in high demand among institutional investors, which resulted in prices above $50,000. 

The decentralized nature of Bitcoin and the fact that investors can use it as a store of value are some of the reasons driving its demand. As a user, you can take have self-sovereign control over your money because Bitcoin is not under the control of any centralized authority. Because of this feature, Bitcoin can also be seen as a way to protect one’s wealth during times of tough economic circumstances. 

Of great importance: Investor and User Sentiment

Remember the infamous Elon Musk tweets that influenced Bitcoin’s price in either direction? 

Well, this is all about investor or user sentiment. For example, when Musk mentioned the word Bitcoin in his Twitter bio, the cryptocurrency experienced a 14% surge in price. Then again, the price of Bitcoin dropped 5% that same year in June when he posted the following tweet:

Also, the following is a chart that indicates how Musk influenced the price of Bitcoin through his tweets:

Musk is not the only popular figure that can affect Bitcoin’s price movements. 

Announcements of Bitcoin investments from institutional investors like Morgan Stanley, Bank of America, or JP Morgan can also create positive tailwinds for the Bitcoin market, resulting in a price increase. Or public companies that invest in Bitcoin like MicroStrategy, Tesla, or Galaxy Digital also improve the overall market sentiment towards Bitcoin, boosting its price. 

Look at Investor Actions

Important to note: Large Bitcoin holders, also referred to as whales, can cause the Bitcoin price to plummet if they suddenly decide to start liquidating their holdings. However, it is due to crypto exchange limits that whales are prevented from selling large amounts in one day. 

Still, oftentimes medium and smaller investors panic-sell in reaction to whale actions, further decreasing downward pressure on Bitcoin’s price.

Heed the Media Hype

One obvious factor driving Bitcoin’s volatility is the media itself. They not only write it after the fact but they can also just as much influence it. For instance, news about the launch of Proshares’ Bitcoin Strategy ETF boosted Bitcoin’s price towards the upside. Shortly after its debut on the New York Stock Exchange, Bitcoin’s price surged by 3%.

Keep an eye out on Regulation

Regulation is something investors should keep an eye out for. When regulators implement new rules that adversely affect the Bitcoin industry, prices are likely to drop. Case in point, China’s Bitcoin mining ban in 2021 hurt bitcoin’s price. Most importantly, however, these effects of regulation on the Bitcoin price are usually short-lived. 

Bitcoin is in its Infancy 

What many people forget when dealing with Bitcoin is the fact that its volatility also stems from the fact that the digital asset is still in its nascent years. Compared to assets like gold that have been around for centuries, Bitcoin is a toddler. As such, the cryptocurrency is currently in its price discovery phase, which most obviously is the most volatile stage within an asset’s life cycle.

The Effect of Global Events

As has been demonstrated recently, global events can affect Bitcoin’s price as well. By way of illustration, when the Coronavirus pandemic crashed global markets in March 2020, Bitcoin’s price took a significant hit too. The same goes for the Ukraine crisis, which creates uncertainty for Bitcoin and wider markets. Having said that, it after both crises the price of Bitcoin rallied thereafter, suggesting that some investors see it as a safe haven asset more than a risk asset.  

Bitcoin Is Volatile, But Not As Much As it Used to Be

The question is: Will this volatility of Bitcoin ever wane? According to an Artikel by Springer, Bitcoin’s volatility was higher in 2010 than in 2020. You can see that from the blue line in the chart below that portrays a slight downward trend. 

Also, this chart on Buy Bitcoin Worldwide shows that the 30-day BTC/USD volatility, represented in blue, has been declining with time.

This slight decline trendline in bitcoin’s volatility could be attributed to its mainstream adoption. Public companies and institutional investors are embracing Bitcoin, reducing its reputational risk for other investors. 

As a consequence, Bitcoin is becoming more legitimate in the eyes of traditional market investors, resulting in more stability. If this trend continues in the coming years, Bitcoin’s volatility would decrease further.

Why Bitcoin Volatility Shouldn’t Matter to (Long-Term) Investors

While Bitcoin’s current volatility is undeniably weighing on investors, the crypto asset’s unique characteristics position the digital currency as an asset that will likely continue to increase in value over time.

Furthermore, Bitcoin’s use as a store of value by both institutional and retail investors means that it will, most likely, always be in demand. Moreover, Bitcoin remains attractive to those that value its decentralized nature. 

Long-term investors should not be concerned by the daily price fluctuations. Why? Because they are mainly holding Bitcoin for its peer-to-peer nature and long-term store of value function.

Additionally, Bitcoin offers several benefits for a diversified portfolio. As reported in a Morgan Stanley research paper, Bitcoin is largely uncorrelated to bonds. Also, it has a rather small positive correlation to the stock market. This means that as the price of the stocks and bonds in your portfolio drop, your Bitcoin will remain unaffected or even move in the other direction. This will result in a better rewards-risk ratio for your portfolio. Also, a monthly or quarterly rebalancing of your Bitcoin position back to its initial weight in your portfolio can minimize volatility and boost returns.

From a long-term perspective, Bitcoin experts agree that the digital currency will hit a new all-time high again in the not-so-distant future. Therefore, long-term investors can just wait for the next 5 to 10 years instead of worrying about the volatility in between.

Abschließende Überlegungen

Experts believe that Bitcoin’s increased adoption will stabilize its price, helping it realize its potential as a currency. Consequently, Bitcoin’s ease of use as a currency would boost adoption even further and potentially make Bitcoin a global currency. 

Therefore, we can expect Bitcoin volatility, as we are experiencing it today to one day wane. Before Bitcoin stabilizes though, investors should expect constant price fluctuations in either direction in the near future. After all, this volatility presents active investors with an opportunity to make money via short-term trading strategies.

Über DDA Ikonische Fonds

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