Nate Nead is the President & CEO of DEV.co, a custom software development company based in Seattle.
Bitcoin has had an interesting history—and one that gives it a reputation for volatility. In many ways, this volatility is understandable; even if the cryptocurrency has a bright future ahead of it, it’s still a relatively new type of asset, and investors aren’t sure how to fairly price it compared to the dollar. But in other ways, the volatility seems irrational, fluctuating wildly in response to variables that may or may not matter to the future of the currency.
In early to mid-March 2020, Bitcoin fell from nearly $8,000 to just over $4,800, eventually stabilizing around $5,400. This comes after reaching $10,000 in late February. But why has Bitcoin taken such a drastic plunge? And is this really driven by the effects of a rational market?
Stating the Obvious
First, we need to take a look at the broader market and understand where the plunge is coming from. Global fears about the Coronavirus pandemic have investors of all varieties scrambling. The S&P 500 has seen substantial drops in recent weeks, triggering “circuit breakers” that intentionally halt trading activity to prevent catastrophic losses and officially bringing the U.S. stock market into a bear market.
It makes sense that investors would panic. For several years, analysts have suspected that the stock market was overvalued. Now, travel is being halted in countries around the world, and the economic impact of COVID-19 is estimated to be in the billions, if not trillions of dollars. Even with a miniscule death rate, COVID-19 could claim millions of lives worldwide and cost millions more their jobs. Some industries, like airliners and travel companies, will be extremely disrupted. Other companies, like those in online marketing, may see a renaissance of activity with more people stuck at home.
Still, why would this affect the exchange of cryptocurrency? Bitcoin’s price is evaluated heavily based on its efficacy as a form of currency. A drop in consumer spending could affect how often Bitcoin is used, but not necessarily in comparison with conventional currencies. In fact, because physical cash carries a ton of germs, Bitcoin could be argued as the safer currency in the wake of a major world event.
Then again, it makes sense why people would be selling off their Bitcoin reserves. Some traders have become overleveraged due to unexpected market volatility; they’ve found the need to sell other assets to cover their margins. Others had too much money in investments, and need to sell those assets to raise cash to cover their expenses.
But there’s another demographic moving the market that may be acting less rationally than these types of sellers.
There’s no question that at least some people selling their stake in Bitcoin are merely panic selling—getting rid of the asset before an anticipated further loss. If they believe Bitcoin is going to drop in price, they sell to avoid that drop, ironically causing the price to drop by their own actions. This doesn’t necessarily reflect the strength of Bitcoin as an asset, but instead may serve as a stronger indication of widespread market fear. People are watching major stock indexes tank, and are constantly hearing panic in the news, so it’s only natural that they would fear the worst for their favorite cryptocurrency.
The good thing about panic selling is that it’s almost always a temporary effect. If people are selling out of speculative fear, and not out of a rational pricing evaluation, eventually—and in many cases within months—prices will return to normal.
Is Bitcoin a Good Investment Now?
I’m not going to give you direct investment advice, but due to Bitcoin’s massive drop, you may consider this to be a decent entry point. To be certain, Bitcoin’s long-term prospects still look good, and a nearly 40 percent drop in price makes this a cheaper acquisition than it was a month ago. However, there are a few things to keep in mind before pulling the trigger.
First, consider liquidity. Liquidity refers to how easy it is to transact a given asset; liquid markets are easy to exit, while illiquid markets are much more difficult. Right now, there is an overwhelming majority of sellers of Bitcoin, with very few buyers. If you need to raise money or if you decide to sell, you may find yourself in a challenging position.
Second, things may get worse before they get better. While many investors are already imagining worst-case scenarios, the long-term impact on the economy from recent events remains to be seen. It’s hard to tell where things will go from here.
That said, the long-term potential for Bitcoin appears to remain stable. If you believe in the advantages of cryptocurrency, and the future of Bitcoin, this price may be a promising entry point. Just make sure you have plenty of cash on hand, and that you won’t be affected by the relative illiquidity of the asset in the short-term.