3 Major Theories Behind Bitcoin Volatility

What would be the reasons for the unpredictable price variations of Bitcoin? There are millionaires who appear to not know about this major issue.

In reality, every cryptocurrency blogger would have their set of arguments. But, aren’t we all tired of reading really long articles where they express their opinions based on freedom of thought?

So, let’s cut to the chase and identify the theories which could have shaped their thoughts.

Theory 1: Price Imperfection Due to Demand-Supply Imbalance

Firstly, to understand the basis of Bitcoin volatility, we have to recognize the fact that Bitcoin is considered the number one cryptocurrency. It was the first one on the block and has garnered more attention than the other altcoins. So we have a lot more people looking at Bitcoin than there are that are focusing on other cryptocurrencies.

In 2017, that number had swollen rapidly. So, in Bitcoin, you have a commodity or an asset that has attracted a lot of demand, and that demand has grown exponentially in the last one year.

bitcoin volatility

Everything that has a price attached to it will be governed by market forces: demand on one side, and supply on the other. Now, this is where things get interesting for Bitcoin. While the demand for Bitcoin has gone up and can be considered limitless in principle (remember the institutional traders who control the world’s money are not trading it yet), the supply of Bitcoin is actually limited.

The fact is that only 21 million Bitcoins have been created and can ever be mined. So far, there are indications that over 80% of Bitcoin have been mined, leaving only 4.2 million coins to be mined until the supply cap is reached.

Bitcoin mining is expensive and energy consuming. Some mining rigs are consuming more power than entire states in some Third World countries. Only a few people will ever have the resources to mine their own Bitcoins, which leaves the exchanges as the only source of mined Bitcoin acquisition for this category of persons.

In other words, most people will source their Bitcoin from exchanges and not from mining. The mining process has been structured in such a way that continuous mining efforts lead to fewer Bitcoin yields per mining cycle. So we have a situation where demand is rising, yet supply is limited and will only get more limited as more coins are mined until we hit the point where no more Bitcoin is available for mining.

This situation has led to the following scenarios:

  • Demand currently outstrips the available supply. Yes, while there are still millions of Bitcoin to be mined, the rate of mining is not producing enough supply to keep up with the bludgeoning demand.
  • Demand and supply disparity from one corner of the globe to another has fueled an imperfect market, where prices vary widely between the various exchanges all over the world. In November 2017 when Bitcoin was $7,000, it was twice the amount in Zimbabwe. This is a country with a very weak currency that was in the midst of a political transition crisis. With investors being driven by fear of the unknown, there was such a massive surge in Bitcoin demand that prices shot up to double the global average.
  • There are already informal markets outside the exchanges where Bitcoin is bought and sold.

Bitcoin pricing is actually a thin balance between what price the Bitcoin holder is willing to sell, and what a buyer is willing to pay for them. Most Bitcoin exchanges set a price floor and a ceiling below and above what the seller is willing to sell. So the final price displayed on the exchange is actually a figure between the upper and lower bands of the price. This will obviously mean that prices will vary between exchanges.

Theory 2: Decentralization Means No Price Control

In the world of fiat currency, there is a limit to the rate of change of currency price movements because there are several points at which interventions can occur. A central bank may decide to buy or sell a currency in large amounts that cannot be matched by any other entity in the market in order to achieve price stability.

With Bitcoin, such controls do not exist. Prices can rise astronomically and also crash in an instant.

Theory 3: Publicity, News and Hype

Demand for an asset is greatly governed by the perception that the buyers and sellers have towards that asset. Human perception is governed by information. That is why opposing forces in a war deploy the power of propaganda as a tool of warfare.

In the financial markets, such information is known as market news. Fortunately or unfortunately, no asset has shown itself to be more vulnerable to the effect of news than Bitcoin.

This actually dates back to 2014 when Mt.Gox, then the world’s largest Bitcoin exchange with 95% market share, collapsed after a series of hacks bankrupted the exchange. That event generated a lot of bad press which really rocked Bitcoin prices.

When the news hits, the response of market participants has been shown to push cryptocurrency prices to extreme levels on both sides.

The cryptocurrency market is one which is heavily driven by news. Ever heard the saying that no news sells like bad news? Well, Bitcoin does sell on bad news, literally.

  • In September 2017, the markets were rocked by announcements from Chinese regulators that all Bitcoin exchanges and ICO products in the country would be banned. Considering that a lot of demand and supply of Bitcoin comes from China, the markets were spooked and Bitcoin lost nearly half its value in a week.
  • December 18 – 22nd 2017 saw Bitcoin shed off nearly $8,400 from its $18,650 value at the time.
  • January 15 and 16 2018: the South Korean Finance Minister re-echoed a statement made by his counterpart in the Justice Ministry to the effect that the government in that country was still considering a ban on the trading of Bitcoin and other cryptocurrencies. The markets have not taken it well, with Bitcoin actually falling below the $10,000 mark for the first time in 6 weeks. South Korea hosts many cryptocurrency exchanges.

Bitcoin volatility: Traits

Such dramatic price swings are now considered to be important characteristics of Bitcoin and other cryptos. They are the result of massive buying and selling in response to the news.

Having said that, there are many other factors which may or may not help in sustaining the economy of the Bitcoin and regulation of cryptocurrency. A person who speculates Bitcoin price charts and has authority to influence the decisions of other potential investors has much more purchasing power than the other folks.

You may ask, why? Because news and other pieces of online information are signals which may trigger Bitcoin volatility. What do you think are the other possible causes? Leave a comment below.

Feature image by Octavian Arnaut 

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