Why is Bitcoin so volatile?

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So you want to play crypto and become a millionaire overnight? Get ready for more days like Wednesday.

Bitcoin plunged as much as 30% to roughly $ 30,000, according to Coin Metrics. Ether fell more than 40% in less than 24 hours, breaking below $ 2,000 at one point. Both made up substantial ground at the end of the day.

But this is part of the course in the world of cryptocurrency trading. Great rises and falls equally drastic. And again.

“Massive pullbacks are always scary, but seasoned investors tend to see them as buying opportunities,” said Mati Greenspan, portfolio manager and founder of Quantum Economics.

Both cryptocurrency and market experts tell CNBC that this is the new normal for investing, and traders should get used to it.

Value and volatility

Bitcoin volatility has to do with many things.

On Wednesday, for example, the news that China is cracking down on banks that complete crypto transactions, in addition to Tesla’s decision to no longer accept bitcoin as a form of payment certainly helped fuel the carnage among digital currencies. The overall crypto market was also due to a correction after weeks of record highs inspired by tweets, courtesy of Elon Musk.

But volatility is also the price bitcoin investors pay for their limited supply and their lack of a central bank to control that supply – precisely the characteristics that proponents say give it value.

Part of what makes Bitcoin valuable is the fact that it is in short supply. There are 18.7 million bitcoins in circulation, which is close to its maximum threshold of 21 million.

The new bitcoins are created as a reward for miners, who contribute their computing power to verify transactions on the decentralized network. Over time, the size of these rewards decreases, so each new completed block generates fewer miners than before.

As a result, the supply of bitcoins is perfectly inelastic. “An increase in demand cannot result in an increase in the supply of bitcoin or increase the rate at which bitcoin is issued,” wrote Ria Bhutoria, former director of research at Fidelity Digital Assets.

The value of Bitcoin is also derived from its decentralized network. There is no central authority that has the power to intervene in the bitcoin market.

“No central bank or government can intervene to support or prop up markets and artificially control volatility,” Bhutoria continued. “Bitcoin’s volatility is compensation for a distortion-free market.”

Also, bitcoin is still very new.

“[It’s] He’s only 13 years old and therefore doesn’t have much of a business history, “explained Peter Boockvar, chief investment officer at Bleakley Advisory Group.” While a company that went public yesterday in an IPO has no track record, a company can at least be evaluated based on its business prospects, earnings and cash flow. “

Because bitcoin is still a fledgling asset class, it remains in the price discovery phase. “[It’s] the most volatile of the life cycle of any asset, “said Mike Bucella, general partner at Blocktower Capital.

“Bitcoin has clearly established itself as a new form of value, but the terminal value is not yet defined,” continued Bucella. “That information gap lends itself to a boost, or technically driven market, in the absence of new information.”

The road to true price discovery is often littered with seismic price swings, but Bhutoria points out that the alternative is artificial stability, which can result in distorted markets that can collapse without intervention.

Get used to it

Bucella believes that today’s commercial volatility will repeat itself.

“There will be many periods like the ones we have seen today where a cycle of negative news has wiped out technical levels (and momentum) in the price of BTC, and those are further exacerbated as market participants start to take advantage of leverage.” . Bucella continued.

What happened today is fairly typical: the spot sale breaks a key level and the leverage is liquidated, creating a more dramatic sell-off than the market would otherwise indicate. Bucella says it has been the same pattern, over and over again, for the last decade, and believes it will continue until we achieve a mature level of adoption.

Ultimately, “high risk, high reward” tends to be the investment rule, and it is especially true in the case of bitcoin.

“All investments carry risks, and like stocks, cryptocurrencies are subject to price fluctuations,” said Noah Perlman, Gemini’s COO. “Bitcoin is still a young asset class, but it is one of the best performing of the last decade.”

Playing the long game is also crucial. “As with any market, crypto investors with a longer time frame and a diversified portfolio will see more consistent results,” explained Greenspan.

The volatility of Bitcoin also has a kind of “halo effect” on companies with exposure to the cryptocurrency.

Tesla, which has a $ 1.5 billion stake in bitcoin, fell about 2.5% on Wednesday. Microstrategy, another company that owns a large amount of bitcoin for its corporate treasury, ended the day down 6.6%, and Coinbase, the recently public crypto exchange that specifically warned on its S-1 that it was vulnerable to volatile movements in the price of cryptocurrencies fell 6%.

But for Bucella, this kind of volatility is a gift that most fund managers in traditional markets would salivate about. “As a fund manager, with proper risk management, infrastructure and tools, this level of volatility presents a huge opportunity,” said Bucella.

Whatever your risk tolerance, experts say that volatility won’t always be that bad.

Bitcoin trading is no longer dominated by retail buyers. American business and professional money managers have flooded the market in the last year and are still getting started. As more institutional investors adopt bitcoin, it gives the cryptocurrency new legitimacy, helping to erase its reputational risk. It also creates more overall stability.

“With increased adoption of bitcoin and the development of derivatives and investment products, the volatility of bitcoin may continue to decline, as it has historically,” noted Bhutoria.

And as longtime value investor Bill Miller pointed out in a CNBC interview Earlier this year, “One of the cool things about bitcoin is that it gets less risky the higher it goes up.”

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