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Bitcoin Volatility Primer
The goal of this article is to explain why the price of bitcoin is volatile and to show how that volatility has been decreasing over time.
As of this article, the market capitalization of Bitcoin is $364 billion dollars. This is simply the current total supply (19.1MM) multiplied by the current price ($19K). To put Bitcoin’s market cap into perspective, if bitcoin were a financial company, it would be ranked just above J.P. Morgan Chase Bank.
The goal of Bitcoin is to become the standard for peer-to-peer payments, without the need for a middleman or intermediary (i.e., Chase Bank). This could disrupt the entire financial system. As a result, Bitcoin maximalists or “HODLers” anticipate the market cap of bitcoin to approach that of the global financial system. If this is the case, bitcoin is still in its “start-up” phase with massive future growth potential.
Internal forces contributing to volatility
Supply is limited. The fact that the bitcoin code limits the total number of Bitcoins to 21MM contributes somewhat to the volatility as the total maximum supply is known and not a variable, like the US dollar. This supply limit puts buying pressure on bitcoin. NOTE: There are more than 21 million millionaires on the planet so not every millionaire can own a single Bitcoin, regardless of price.
The rate of new supply (inflation) of bitcoin diminishes over time. The inflation of Bitcoin is paid to miners who process and publish new blocks to the blockchain. Miners need to sell Bitcoin to cover their operational costs. Also, the percentage of new supply entering the market is ever decreasing when divided by the current bitcoin supply. When Bitcoin started, mining rewards were 50 BTC per block. 50 BTC added to a then-current supply of zero was significant but became less so with each block. During the last halving, block rewards were cut in half from 12.5 BTC to 6.25 BTC, resulting in a minuscule percentage of new supply being added. In other words, the inflation rate of Bitcoin will always trend towards zero. Bitcoin will become totally deflationary after the last one is mined, sometime in the year 2140.
Another significant fact is that only 2% of the bitcoin wallets possess over 94% of all Bitcoins. According to GlassNode, these wallets have had a net increase of Bitcoin since the recent Terra Luna UST debacle. This concentration of Bitcoin, in so few wallets, adds to the volatility since they control over 9 of every 10 bitcoin that exist today. Fortunately, for new investors, these “whales” need a bigger market in which to splash around. I do not expect them to become net sellers at these price levels.
Market forces contributing to volatility
As I mentioned in a previous article, the cryptocurrency market is a reflexive one. Simply means, that new retail buyers enter the market when the prices are rising in a “fear of missing out” or FOMO. Eventually, this buying pressure wanes as their funds dry up and a new all-time high is reached. As the ensuing market correction begins, those with “weak hands” start to sell as their dream of sudden wealth turns into a nightmare. This market reflexivity exacerbates the price movement in both directions to extremes. As a result, Bitcoin has had numerous corrections of over 85% after reaching a new all-time high.
External forces on bitcoin
As previously mentioned, the internal workings of the bitcoin code impact volatility. The volatility index compares the daily price fluctuations of bitcoin to the US dollar. As we know, the US dollar and other major foreign currencies have had significant increases in supply as trillions of new dollars were printed “out of thin air”. This new money supply was the result of quantitative easing measures by global central banks and accelerated in response to the recent pandemic. These actions by central banks had a significant role in the recent bull phase of bitcoin as stimulus check funds and cheap borrowing rates pushed Bitcoin and other cryptocurrencies to new all-time highs in the last quarter of 2021.
How has volatility trended over time?
Looking back at previous Bitcoin halving market cycles; since inception, the daily price volatility as compared to the US dollar decreased slightly from the previous cycle. Evidence of this can be seen below:
² Date when bitcoin had price discovery in US dollars terms
In conclusion, the volatility of bitcoin is a factor in the design of Bitcoin, the behavior of its participants, and the external actions of central banks. As Bitcoin moves along its adoption curve, the volatility will decrease. True “HODLers” ignore daily volatility and instead focus on trimming their gains as new highs are reached and use the proceeds to acquire more bitcoin after it forms a new market bottom.