It seems like there is breaking news about Bitcoin every day. The price is extremely volatile and it is generally seen as a risky asset, but what is causing this? Investing in Bitcoin is a crazy ride and it is a true struggle to keep up.
There are a few factors that have a large effect on how the price of Bitcoin fluctuates over time, and once they are broken down, it is pretty easy to see how external forces influence the price.
Liquidity and Accessibility
Bitcoin hasn’t changed much over the last decade. Since its inception, a lot of work has been done on it, but the fundamentals are still very similar to those at its genesis. So why is the price constantly increasing? A large part of this has to do with how accessible it is.
Intermediaries are continually entering the market and making it easier to buy Bitcoin. Whereas someone would have had to have a strong understanding of computer sciences and then figure out how to buy and store it on their own, there are now services and platforms that make all of this very easy.
Companies like CEX.IO, for instance, act as centralized platforms for the purchase and storage of Bitcoin, and they have experienced rapid growth as more and more customers joined the platform. The value proposition of these companies is to make it extremely easy to invest in cryptocurrency using fiat money (to see the full list of supported currencies, you can refer to the review of CEX.IO). By doing this, the audience that can be reached by the companies greatly increases. More people are able to invest in the asset class, and so they do.
Bitcoin as a Hedge
Many of the most libertarian and intense Bitcoin fans see Bitcoin as a hedge against a downturn in the economy. The belief is that the monetary controls around the dollar make it a largely useless asset, since its value is constantly being inflated away. Bitcoin is a deflationary good and has been increasing in value (in terms of the USD) for quite some time.
When an asset increases in value in terms of another asset, one of two things may be happening. The obvious result is that asset may be appreciating, but it could be that the other asset is depreciating. Knowing this, it is easy to see how the faith of investors in the economy would affect the price of Bitcoin.
The more unsure people are about the future of the U.S. (or global) economy, the more fluctuations there are going to be in the price of Bitcoin. And much like how gold is considered to be a hedge against any crash in the stock market, Bitcoin would likely have a high negative correlation as well.
Of all of this, the most important factor in the high volatility is market sentiments. Investors are a fickle bunch, and if a certain persuasive argument is put out, or there is a small swing in the price, there can be rapid contagion.
Most of the investors in Bitcoin are not accredited investors, and seldom have the long years of trading experience and emotional control required to weather big swings in the price of Bitcoin. This is why we’ve seen such drastic fluctuations in the price as it starts to drop. Investors experience the uncertainty and fear, and decide they can’t hold onto their Bitcoin any longer and sell. The crash of early 2018 is a prime example of that.
On the flip side, you have many investors who bought into Bitcoin because everyone else did. This “fear of missing out” happens more often with ideologically motivated investments like Bitcoin, where there is true potential to change the world and investors can get passionate about it.
Recent news stories have shown certain institutions try to prevent access to Bitcoin, or at least make it harder. The Bank of Montreal recently decided to ban the purchase of Bitcoin using any of their services, and email service provider MailChimp is banning any email newsletters around cryptocurrencies.
The short-term effect of these will be a lower demand for Bitcoin, but in the longer term, it will strengthen the perceived need for something like Bitcoin. Of all the benefits that stand out about the cryptocurrency, the top one is that it is censorship resistant. No one can control the flow of funds and you can spend it on what you wish. Many people perceive this to be enabling commerce with drugs and weapons, but it also means no government may have control over your ability to buy or fund something, which is basically taking the First Amendment to its logical extreme. These sorts of beliefs are the number one reason that Bitcoin prices fluctuate so much: people have very strong feelings on one side or the other.