Bitcoin’s price has been on a seemingly catastrophic and cathartic rollercoaster ride since March of last year, when the price was as low as $3,000 amid the chaos surrounding the pandemic. Interestingly, the asset has successfully surpassed the much anticipated $20,000 ceiling over the past year and gone as high as $64,000 before the fall to the $32,000 range in July 2021.
One of the driving factors behind the wild ride could be the smaller circulating supplyCirculating supply is the number of cryptocurrencies or tokens that are publicly available and circulating in the crypto... of Bitcoin. On-chain data shows that about 18,754,987 BTC in the market are in circulation on July 13, 2021, and the number continues to get smaller as the year progresses.
According to blockchain data assessments, the decreasing supply of Bitcoin drives the price to new heights, as larger investors rush toward Bitcoin as a good store of value. As a result of the recent Bitcoin halving, several Wall Street institutions, including Goldman Sachs, Citigroup, and BlackRock, Grayscale Investment, are embracing cryptocurrencies as an asset class for investments.
However, despite the support from payment giants such as PayPal or the celebrities’ promotion on social media, Bitcoin has recently proven its extreme volatility as the price plummeted by over 40% to as low as $34,000.
What Are the Factors Contributing to the Volatility?
There could be many factors contributing to Bitcoin’s recent precipitous decline. A lot of it has to do with FUD (Fear, Uncertainty, and Doubt). Recently in May 2021, the China Banking Association barred institutions from providing services that employ digital currency because of its volatility. At the same time, tech mogul Elon Musk has announced that his company, Tesla, isn’t going to accept Bitcoin as a form of payment anymore because of its voracious appetite for electricity and allegedly wasteful consensus algorithm.
Bitcoin’s price took many hits amid pressure from Musk’s comments and the legislation from the Chinese Government. In the aftermath of Musk’s comments, investors moved $98 million out of Bitcoin investment products into other assets such as gold and Ether. Similarly, amidst chaos from Musk and China, large crypto holders — commonly known as whales — moved 12,000 bitcoins, roughly about $600 million, out of Coinbase.
A lot of cryptocurrency prices are caught in a constant battle between fear and trust. Since the asset is fairly nascent compared to the age-old commodity and stock markets, cryptocurrencies continue to surge and plummet. The most recent example is that Bitcoin rallied toward the $40,000 threshold after El Salvador declared the digital asset legal tender. But BTC price has soon plummeted to $30,00 threshold amid China’s crackdown on Bitcoin mining.
This brings us to the main questions: Why are cryptocurrencies so volatile, and why are they so sensitive to fear and trust?
What Does Healthy Market Volatility Look Like?
Volatility essentially refers to changes in the price of an asset. Volatility or price change, in this case, could be healthy — with gradual increases and decreases in price within a specific range — or it could be extreme, with aggressive price movements in uncertain directions.
Extreme volatility often carries negative connotations because many equate volatility with market chaos, uncertainty, doubt, and fear of loss. In aggressive markets, investors and traders tend to place bets anticipating continued swings. An example of extreme market volatility is the 2008 Financial Crisis, which caused the stock market to collapse.
Actually, such cases are rare, and what we see in markets daily is healthy volatility. During healthy volatility, price changes occur as traders and investors adjust to information and speculation about companies, industry, and macroeconomic sentiments. Investors and traders evaluate market conditions and buy or sell accordingly, based on how they feel the factors will affect an asset’s price.
Studies show that some of the most common factors driving volatility in various markets include rapid news cycles inciting speculators to move in and out, increasing institutional investors, and the emergence of derivatives markets.
As we all know, crypto volatility is very different from that of traditional markets. There are no indicators to measure cryptocurrency market volatility. Traders assess the assets fundamentally by looking at historical price charts and analyze the aggressive peaks and troughs, which occur at a more aggressive pace than in traditional markets.
Interestingly, many of the factors that drive volatility in traditional markets also apply to the cryptocurrency market. And just as in traditional markets, speculations, news developments, the emergence of institutional players, and derivatives markets also drive volatility. However, the effects of these factors are amplified in the crypto market, which leads us to another question.
Why Does Bitcoin’s Price Surge and Plunge so Quickly?
The market sentiments have a great impact on Bitcoin’s volatility. While the VIX or CBOE volatility index is great to measure the level of risk, fear, or stress in the crypto markets, which applies to Bitcoin investment. Still, here are some other reasons in fundamental analysis that tell why Bitcoin’s price surges and plunges so quickly.
Bitcoin Whales and Institutional Players
Whales and institutional players (investors) play a crucial role when it comes to manipulating asset volatility. According to experts, crypto whales who deposit a significant volume of their Bitcoin holdings to exchanges could be one of the driving factors behind Bitcoin’s extreme price drops. These crypto whales deposit large amounts of their holdings to cash in on the asset’s price surges.
Studies show that when whales and institutional players buy dips during an asset run-up or sell when prices surge, most retail investors choose to copy these players, which significantly shifts the prices.
Regulatory Uncertainty
Bitcoin, like other cryptocurrencies, is very sensitive to speculation and legislation. This is why regulatory uncertainty is one of the main factors affecting Bitcoin’s sudden price drops. We can take examples from both China and the United States. Regulators in the U.S. have shown, time and again, both their resentment toward — and weird support for — Bitcoin.
However, amid recent speculation that the U.S. treasury department is planning to introduce a mechanism to monitor users’ wallets, many asset holders sold their assets. Similarly, when the China Banking Association barred financial institutions from dealing with digital assets, Bitcoin plummeted by over 40%.
Speculation
One of the most crucial factors driving volatility in the market is speculation. The speculation involves investors predicting and placing bets on whether the price of an asset will surge or plummet. Not surprisingly, a lot of this has to do with the market’s inherent volatility — the very thing that attracts speculative investors to make money by guessing swings.
Investors often look to make money with such predictions, buying right before either event occurs. Investors often profit from short-selling their assets right before crashes. With an increasing number of speculative investors joining the market, these speculative bets often cause more volatility in an already volatile market.
Social Media and Communities
Despite the emergence of cryptocurrencies into mainstream media, the market size is small compared to the age-old fiat currency and gold markets. At its peak, the cryptocurrency market was worth around $2 trillion, compared to the $28 trillion U. S. stock market and $8 trillion gold market.
The smaller cryptocurrency market is prone to shifts and ripples, in contrast to larger traditional markets. However, the cryptocurrency market is still developing and is relatively new. This means there is a myriad of opportunities amidst the crypto market’s new and exciting developments.
Since the cryptocurrency market is fairly small, with tons of speculation, social media and communities have a massive impact on where prices go next. This is because speculative traders and investors are often on the hunt for the next big headline and are in a constant race to buy or sell to profit the most. The increasing number of investors joining the market has allowed media stores surrounding cryptocurrencies to impact asset prices significantly.
Derivatives Trading
Another factor that could be responsible for Bitcoin’s sudden price movements is the emergence of derivatives trading. Drops in Bitcoin price can be accompanied by mass liquidation of numerous derivatives positions, leading to market overheating. This causes overleveraging in the futures market.
The value of perpetual contracts surging over the value of Bitcoin and its underlying equity could be a driving factor behind Bitcoin’s aggressive price drops. Cryptocurrency trading has developed into a complex environment, with an ever-increasing number of sophisticated and institutional products such as futures, leveraged margin trades, and DeFiDecentralized Finance (DeFi) takes the decentralized concept of blockchain and applies it to the world of finance. Build... protocols. However, a sudden drop in Bitcoin’s price could start a domino effect of automated responses executed by trading bots within milliseconds, resulting in a sudden oversupply of Bitcoin. This would therefore amplify the price drop.
Investor Caution
While there are a fairly large number of HODLers who have gone through thick and thin to hold onto their assets, many small investors may not possess the same resilience and perseverance needed to survive the extreme price swings.
Investor caution is one of the many reasons why Bitcoin goes through extreme price drops and surges. FUD and FOMO play a significant role in investors who don’t share the same patience as veteran HODLers. When Bitcoin’s price goes through sharp shifts in either direction, investors often become stressed and buy or sell accordingly.
Will Bitcoin’s Price Go Bull Again?
With El Salvador’s debacle and Tesla’s conditional acceptance of Bitcoin, if miners use cleaner energy for their mining processes, Bitcoin’s price is stabilizing and could attract institutional investment. With rumors surrounding Central American countries jumping on board with El Salvador to accept Bitcoin as legal tender, it’s possible for Bitcoin’s price to stop plummeting.
However, predicting when and where this bullish run will end is hard to do. Numerous external variables are at play, such as the pandemic, unexpected regulatory fallout, the difficulty in predicting crypto whale moves, and the uncertainty of where the market will move. Until there are regulations to stop market manipulations, anything could happen to Bitcoin’s price.
Before you decide to hold on to your positions or exit existing ones, you must understand that there are numerous stakeholders in the market, and each of them plays a crucial role in the movement of Bitcoin’s price. So resist the pull and push of FOMO and FUD, do your due diligence, and be patient.
