Here are three reasons why Bitcoin is so volatile. Bitcoin crashed over 20% from its all-time highs. And it took the whole crypto market with it. All crashes are painful, but it’s important to realize that they’re never a loss unless you sell.
Despite any preconception, you can handle such volatility without coming across like a heatless trader.
How volatile is Bitcoin?
But before anything else, let’s take a look at how exactly Bitcoin is volatile. The following statistic is quite interesting.
As you can see on the chart below, Bitcoin's volatility is about 7x higher than the S&P500's. To put it another way, a 12% move in BTC would be equivalent to a 1.7% move in the S&P 500 index.
Equally important is to look at implied volatility, which captures the market’s view of the likelihood of price changes. According to Skew, the probability of a daily price change is about 4.7%.
Three reasons for high volatility
Let me break down for you three reasons why Bitcoin is so volatile.
First, Bitcoin is only 12 years old, and it’s still in the early days in the competition for sound-money market share.
Every new technology goes through high volatility in the beginning. So the best way is to treat a Bitcoin investment like venture capital because it’s much younger than other major assets.
Second, Bitcoin is open for trading 24/7. Unlike trading stock and commodities, the Bitcoin market never closes. Imagine if it didn’t trade every second of every day, but you could only exit it five years after you invested. Like with any venture capital investment, you’d mark the value of the asset at cost and wait patiently for five years. Anyone who has treated the Bitcoin investment this way has seen exponential returns.
And finally, Bitcoin is massively traded on margin. In other words, people are paying for it with borrowed money. Some exchanges even allow their uses to take up to 100-to-1 leverage. As a result, the automatic selloff triggers a domino effect that leads to massive liquidations when the price goes down. And given the volatility of Bitcoin, 100x leverage is always a bad idea.
The simple way to understand Bitcoin volatility
Here’s the most compelling perspective on bitcoin’s volatility.
Bitcoin has always been volatile, but only relative to the dollar. In some ways, you can argue that the dollar is highly volatile against Bitcoin as it slowly works its way out of the financial system. In other words, it doesn’t matter whether the price is $3,000, $30,000 or $300,000.
No fiat price tag matters because all paper money eventually returns to its intrinsic value, zero.
As Tim Draper, Founder of Draper Associates, likes to say, “one Bitcoin is still worth one Bitcoin, but over time all the other currencies are slowly falling away.”
Another way to understand Bitcoin’s volatility is through the lens of inflation. To demonstrate, here’s an example. If you live from paycheck to paycheck and watch Netflix as your hobby, you don’t need to worry about inflation. However, if you aspire to buy a house, have three kids, and go on expensive vacations, you have a significant inflation problem to solve.
In other words, your life aspirations determine your fear of inflation, which in effect determines your fear of Bitcoin volatility.
Do you see how straightforward it is?
Simply realize that volatility is a necessary evil, and it is the price you pay for the extraordinary performance you get. It’s a feature, not a bug.
To summarize, if you make volatility disappear, you make the opportunity disappear as well.