Yes, Bitcoin is volatile. In fact, it's very volatile. Since its conception in 2008, Bitcoin has had stellar price performance, and as part of that performance, the price per bitcoin has been subject to vast and rapid fluctuations. This volatility has been polarizing. Some people are put off by it, others find it enticing. It is its very own world; difficult to put into perspective for external observers, especially those rooted in and accustomed to more traditional investment approaches.
What does the history of bitcoins’ volatility show us? What are the causes? And what does this mean for us?
In this context, we will outline key reasons for this volatility and dive into its driving mechanisms. After all, bitcoin is seen as a resilient store of value and its volatility is a result of many different market dynamics which need time; to be both understood and successfully navigated. — Author: JP Patheja Hellmich
Historical Bitcoin Volatility
Bitcoin has always been subject to large price fluctuations.
Figure 1: Bitcoin Logarithmic Growth Curves1
It’s no secret that bitcoin is considered to be an extremely volatile currency. For instance, the volatility of gold averages 1.2% whereas bitcoins’ volatility in the last 60 days alone has averaged 4.6%, and not uncommonly even far exceeds the 7% mark2.
February 2011 marked the time when bitcoin first reached parity with the USD. Priorly it had only traded in the sub-$13 range. Succeeding the milestone, bitcoin reached $17.50 by late June of that year. However, it did not last long. Following an alleged hack at Mt. Gox, a major platform for trading crypto currencies at the time, bitcoin fell from it’s new high to a mere $0.01 - Yes, you read that correctly - where it remained for a couple minutes.
After an extended period of ups and downs, a rather peculiar split of the blockchain into two occurred in March 2013 where for six hours two iterations of the transaction log (blockchain) operated simultaneously which led to a mass sell-off4. The technical crisis was due to a bug from differing software versions 0.7 and 0.8 which lead to the fork. Quick decision making prevented significant damage, version 0.8 was reverted, and by April 1st the price of bitcoin reached $100.
While in the summer of 2013 Thailand banned bitcoin exchanges due to a lack of legal frameworks, a US federal judge determined that bitcoins are “a currency or a form of money”5 just as Germany’s finance ministry also classified them as a “unit of account”6. This, along with an increase of support for bitcoin fueled its rise to $1,000 which peaked at $1,150 by November 30th, 2013. The glory didn’t last, only a week later the price came tumbling down by $450 and marked the beginning of a long slump which bottomed out at a price of $203 in August, 2015.
It took until January 2017 for bitcoin to return to the $1,000 mark. From there it went ballistic: $3,000 in June, to $5,000 in September and all the way to $10,000 in November. Cboe Global Markets began offering bitcoin futures in December and by the 19th of December (2017) the price peaked at $19,200.
After several events in January 2018, these include South-Korea implementing a regulation that everyone trading bitcoin must be identifiable; Facebook banning advertisements of all cryptocurrencies (and later also Google); as well as some companies phasing out their support for bitcoin on the grounds of low demand and high latency7, saw the price fall by over 50% to a mere $8,285 by early February. This, however, was not the end of the dwindling prices yet: After a statement by the US Securities and Exchange Commission in March, fear started to brew over the regulation of cryptocurrencies and by the end of the year the price dipped below $4,000. For the second time now a major ‘bubble’ - as it is commonly referred to - burst.
Although it certainly left a sour taste behind for many, many more saw the immense opportunities cryptocurrencies, and of course specifically bitcoin, offered. Bitcoin had succeeded in gaining the attention of the masses.
Recent developments and reasons for volatility
Over the next months and years, with popularity and prices rising, we saw it return to $10,122 in early February 2020, which by March, with the onset of the Pandemic, nearly halved again to $5,355. This time the recovery, arguably due to inflationary fears and general uncertainty, came quickly - but had more traction. By July the Covid related crash recovered and from there the bitcoin price doubled by the end of the year. Early 2021 was a major bull run, MicroStrategy, the first publicly traded company, started to invest a significant amount of treasury assets in bitcoin. Combined with the news of Tesla purchasing $1.5 billion in crypto and accepting it as payment8, bitcoin propelled to an all time high at a staggering $63,346 on April 16th, 2021.
Only two months later, Elon Musk expressed his concerns about the environmental impact of bitcoin and decided to retract the possibility of purchasing a Tesla using the cryptocurrency9 causing an immediate 12% dip in the bitcoin price. Yet, two other issues loomed just around the corner:
1) The Chinese government issued a warning against mining and trading crypto: all financial institutions are prohibited entirely from offering any crypto-related services; are banned from accepting or paying with crypto and from offering crypto-related financial products10. Essentially, this implied and fueled the fears of heavier regulation.
2) Inflation had finally also hit the officially reported Consumer Price Indexes (CPI) in major markets and inflation warnings started to dominate headlines. This sparked expectations of higher interest rates. While bitcoin is seen as a store of value and hedge against inflation, it is still considered a "risk-on asset“. And when investors expect interest rates to rise, they typically drop risk-on assets such as stocks or cryptocurrencies for risk-off assets such as U.S. Treasuries or German bonds, which would directly profit from an increase in interest rates. As a result of these events, the price of bitcoin continued to plummet by over 40% to $35,846 as of May 30, 2021.
After having abundantly illustrated bitcoins’ notorious volatility there is an interesting trend: The crash of 2011 was due to the hack at Mt. Gox; the crash of 2013 due to a bug in the software; the crash of 2018 was due to fear over regulation; the crash of 2020 due to Covid related fears and lastly, the crash of 2021 was due to Tesla, Chinese regulation and the expectations of rising interest rates.
For bitcoin, the arguably biggest economic development of the last centuries, which presumably is still in a nascent stage, to move from being influenced by technical malfunctions to macro-economic factors instead, is certainly a form of development. Although bitcoins’ price development has been a bumpy ride thus far, there is an entire domain to blame which is seldomly called out.
What is causing the volatility? The power of FUD and FOMO.
The rapid volatility plaguing bitcoin seemingly shares little correlation to other currencies, commodities or differing stores of value, and FUD is to blame, at least partially. FUD is an acronym which stands for Fear, Uncertainty & Doubt11. It‘s a propaganda-like strategy used in marketing, sales, PR and also politics.
Overstating events outcomes, redundantly reiterating risks, slippery slope arguments and loose interpretations of data are disingenuously used to make sales. Essentially, FUD works because we are loss averse beings, meaning the fear of losing something greatly outweighs the pleasure of gaining that same thing. Losing $10 feels worse than finding $10 feels good. We will, for the fear of losing - be it wealth, safety or anything else dearly valued - make irrational decisions.
Commonly, FUD is created and spread on social media. For example, Jamie Dimon, the CEO of JP Morgan tweeting “if you’re stupid enough to buy it, you will pay the price for it one day”12 in regard to bitcoin, is an instance where FUD can be created. What his motive behind the tweet was is beyond the scope of present analysis, however, the retweets and media frenzy his tweets created are certainly a common practice for creating FUD to steer retail investors i.e. individuals or non-professional investors, away from cryptocurrencies - and perhaps back towards the more traditional institutions.
Inversely, Fear of Missing Out (FOMO) is also the same principle but the other way around. Instead of trying to get retail investors to steer away from crypto or an investment, the aim is to get more people to join the movement. Essentially FUD (in this case fear) is created that the person is missing out on something big.
Perhaps also uncertainty or doubt that what they are doing may be the wrong decision - analogous to the way we are sometimes pressured by friends to join them for dinner or a night out and do actually end up going because we don’t want to miss anything, or simply because everyone else is going.
The latter is known as the “Bandwagon effect”. Rather than giving one specific example, I will take the liberty to assume you are also constantly being reminded which major firm has bought into or implemented crypto; which acquaintance's friend made x amount of money overnight and which celebrity has also become a crypto investor/guru. For many, this translates to FOMO, and since everyone is on the bandwagon already, what could go wrong? - surprisingly, quite a bit.
Dumb Money and why education is pivotal
The neologism Dumb Money implies trading independent of fundamentals or rationale - such as the instances described above. The cryptocurrency Dogecoin is a prime example of dumb money. It was started in 2013 by two software engineers Billy Markus and Jackson Palmer, as a joke to poke fun at the speculative nature of cryptocurrencies13. It started out at $0.00026 and five years later was worth $0.017 per coin - which albeit a multiple fold increase still doesn't sound that impressive. However, after a TikTok trend; some Elon Musk tweets; Snoop Dogg (yes, the rapper) and Mark Cuban endorsements - just to name a few, the coin reached a peak of $0.73 with a market cap of approximately $81 billion14 on May 8th, 2021. To put that into perspective: Adidas has a market cap of $72.0 billion; BMW $67.0 billion; while Ferrari and Honda both have a market cap of roughly $53.0 billion15.
Figure 2: Dogecoin Logo16
So where is the problem? Inherently, there is no problem with a cryptocurrency surpassing many large established companies (quite the contrary!) - the problem lies in Dogecoin’s value, or rather lack thereof: Dogecoin was created as a joke; it serves no purpose (amusement aside); has extremely limited real-world applications; there is an unlimited supply which is constantly being further diluted with additional mining; and it has been completely inflated by media hype17.
Similarly, this applies to Shiba Inu coin or SafeMoon coin (both with market caps is in the billions), as well as to other meme coins like Garlicoin, Loser Coin, Banano or Pepemon Pepeballs (all with market caps in the millions)18.
In contrast, although Ethereum has also recently taken a plunge (at the time of this article), there is great thinking and rationale backing it. Ethereum was created as an improvement to bitcoin through revolutionary features like Smart Contracts which allow for decentralized agreements which are self-executed. This has a wide variety of real-world applications such as enforcing financial agreements, operating as an escrow service for expensive goods or even to enforce employment contracts19.
Bitcoin too has revolutionary features. After the 2008 economic collapse in our centrally regulated system, a white-paper titled “Bitcoin: A Peer-To-Peer Electronic Cash system” was released by Satoshi Nakamoto, a pseudonym for the person or people behind bitcoin. In this white-paper, Nakamoto describes a decentralized peer-to-peer version of electronic cash. In this, the hash-based proof-of-work algorithm logs the sequences of events, immutably. In 2009, Nakamoto released the first block, called the Genesis block. In this he hid an easter-egg (a hidden message) which reads: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". This has been interpreted to be the central reason behind bitcoins’ conception: to create a decentralized more efficient system free of corruption, banks and middlemen in which ‘the people’ have the power20.
Lastly, when the prices are going up - experts refer to it as a bull run. When the market is going down, words such as “crash” and “correction” are being used interchangeably21. A crash happens in situations such as described earlier when institutions announce crypto related regulations, bannings or other market related information make headlines. A correction on the other hand, happens when institutional investors have decided they have had enough profit or for other strategic reasons, start to divest and inject bitcoin back into the market.
To boil it down, it is important to understand that many current cryptocurrency prices are driven by FUD and FOMO, which inherently implies volatility. Although FUD and FOMO are universal drivers, as it applies to value-backed cryptocurrencies as well - and not just meme coins - it is vital to differentiate between the two; similarly to the way we would not interchange investing and speculating. That is not to suggest success can’t be had with the latter, however, caution is warranted.
Bitcoin, having been conceived in 2008 has truly gone through a lot: enormous price fluctuations, software malfunctions, hacks and strict regulations. It has been quite a bumpy ride, however, for a technology as young as bitcoin, and as revolutionary as bitcoin to prevail is a statement in and of itself. We have seen the immense impact fear, uncertainty and doubt have on its volatility. Not to forget to mention the influence of social media and prominent individuals like Elon Musk.
It is abundantly clear that this disruptive technology is still taking time to find its place. It is also clear that traditional approaches are no longer sufficient, even in the case of the financially literate, a new approach is due. Currently, the difficulty for most lies in navigating the unfamiliar terrain and grasping the concepts that underlie this technology. This is where we at 21Treasury are here to help you. Get in touch with us and we will be happy to tell you more!
3 Bitcoin prices obtained from: coindesk.com/price/bitcoin
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