Why is Bitcoin so volatile?

We know that the more volatile the price of an investment is, the more risk you take on by putting your money in it (and the higher returns you potentially stand to gain).

This is no different for Bitcoin.

Over time, we’re seeing Bitcoin’s price becoming far less volatile. On average, the daily volatility rate (how much the price changes per day) has been mostly under 5% since 2015. The market is still relatively small, so this is a considerably reasonable rate; and not that variant to gold and most major currencies (which have far larger, more mature markets). Here are some of the factors that contribute to these price swings:

1. Bitcoin is still a new technology

Bitcoin is relatively young, having only been around since 2009.

By contrast, the internet has been around since the early 1960s, space travel since 1957 and artificial intelligence since 1956. It takes time for a new technology to evolve and find its place in our lives. Bitcoin is both a new technology and an investment. Investing in Bitcoin is a positive nod to the technology, but it’s still early days.

Unlike many new technologies, we have an obvious public sign of where Bitcoin is: its price. Although the swings in price are normal, it’s visible, which makes us more aware of the volatility.

Bitcoin is still developing and gaining mainstream awareness as we all figure out its purpose and how it will add value to our lives. Whatever the price charts say, the technology continues to improve as it slowly becomes a productive part of our lives.

2. Bitcoin was illiquid until recently

There’s only 21 million Bitcoin available and not all have been mined yet. Much of the available Bitcoin is held by a few people. It’s estimated that 4% own 95% of the available Bitcoin and 1% own half. The result is limited liquidity.

Liquidity refers to how easy it is to buy or sell something, without changing its price.

When there’s not much liquidity, that means only a few people are willing to sell or a few are willing to buy.

Many of the largest Bitcoin holders were unwilling to sell under any circumstances. So if someone tried to buy a lot of Bitcoin at once, there wouldn’t be enough available. This would push the price up until more people sold. The same happens in reverse. If a lot of people decide they want to sell their Bitcoin at the same time, there might not be enough buyers. Prices might then drop, until the lower price attracts more buyers.

Once again, that’s changing. More people than ever are buying and selling Bitcoin, so there’s more liquidity in the market. This helps to even out prices.

3. Investing can be emotional

Emotions shouldn’t be part of the equation when it comes to investing, however, this isn’t always the case. When the price of Bitcoin drops, investors tend to experience what has come to be known as FUD: fear, uncertainty and doubt.

They fear the price will keep dropping. They are uncertain if it will ever increase again. They doubt themselves for investing in the first place. So they sell their Bitcoin. Often, this isn’t triggered by a real change in Bitcoin’s value, just by rumours or the price drop. Price changes are a normal part of any market.

Similarly, when the price of Bitcoin increases, people experience FOMO: fear of missing out. They fear missing out on a chance to get rich and they expect the price to continue increasing. So they start buying Bitcoin, increasing the demand and increasing the price. This enhances natural fluctuations.

One way to think of this is to imagine you are buying a new laptop. You’ve had your eye on one costing R10,000 for a while but you’re hoping it will go on sale. If the price gets reduced to R6,000, you immediately buy it. But that’s not how we always act with investments. Our FOMO might make us buy the laptop when it’s more expensive because we think we might be able to sell it for more. Our FUD might make us sell it when the price is lower because we think it might get even lower.

4. Bitcoin price is sensitive to the news

Much like investments in traditional stocks, or foreign currencies, Bitcoin’s price can be affected by the news. Common news items that affect the price include:

• Articles about new regulation or action from banks and governments
• Statements from well-known figures in tech and investment
• News of hacks or security breaches
• Rumours and incorrect information

These are just a few of the factors affecting the price swings of cryptocurrencies like Bitcoin. Before making any investment decisions, it’s important to understand what you’re getting into.

The price can change in moments so the value of your investment will change over time, perhaps by a lot. Try not to let strong emotions get the better of you. Doing your own research, and speaking with financial experts will help you make a more educated decision.

If you want to monitor the price of Bitcoin or Ethereum, you can easily set up price alerts in the Luno app. Simply open the side menu in the app, click on “Price Alerts” and decide when you want to be notified.

Want to learn more? Read Luno's Bitcoin education series here.

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This article was paid for by Luno.