The Reasons Behind Bitcoin’s Volatility
Bitcoin prices have always been very volatile, and huge swings in prices were witnessed many times. In the equity or commodity trading markets, a volatility index measures the volatility. This index is called the CBOE Volatility Index or VIX. In the year 1993, the Chicago Board Options Exchange (CBOE) created VIX that is a real-time index representing the market’s expectation over the near future. Recently, a volatility index was designed for bitcoins in the same lines as the CBOE VIX. Named Bitcoin Volatility Index, this is an indicator of the market mood and also analyzes the volatility of the digital currency. This volatility index considers the cryptocurrency’s market capital over different periods.
During three months from Oct. 2017 till Jan. 2018, the volatility of bitcoin prices climbed up to 8%. During the period from 15 December 2019 to 15 January 2020, the volatility was less than half of the 2017-18 high volatile period. These swings in the spot rate of bitcoins (for selling or buying a bitcoin, the spot rate is the contract price for immediate settlement) depends on many elements or factors.
News Driven Volatility
Certain news published by the media, including political statements by world leaders on regulations on bitcoins, geopolitical events, etc. controls the price movements of bitcoins. Some of the amateur traders The novice users or adopters of bitcoins, have an intrinsic fear that the cryptocurrency will be regulated by governments, so the prices of bitcoin start falling with such news. When the news of the electronic fraud and following insolvency of Mt. Gox exchange in April 2014 was leaked, the prices of bitcoins crashed down.
Similar volatility in prices was noticed when the S. Korean crypto exchange, Yapian Youbit filed for bankruptcy after hacks when it lost 17% of its assets. Some other news like usage of bitcoins for drug-related transactions via the Silk Route resulted in the FBI shutting down the exchanges in Oct. 2013. These events pushed the value of bitcoins down very fast compared to fiat currencies. But, a positive trend in the price of bitcoin was seen within a short period when bitcoin regained its position versus the dollar. According to cryptocurrency promoters, these events only show that the bitcoin market is maturing as the prices come up to the previous levels very fast.
Perceived Value of Bitcoin Moves
The perceived value of bitcoins is a reason for the fluctuations of its prices versus the government-controlled currency (fiat). Like gold, bitcoin is also recognized as a safe asset that investors often buy as a hedge to their portfolio. It also has fundamental similarities with the yellow metal as the supply of both is limited. Bitcoin is regulated by the protocols of its blockchain, and there is a limit to the total number of bitcoins that will be available.
At the time of the introduction of Bitcoin in the year 2009, the developers fixed the total number at 21 million Bitcoins (BTC). This is radically different from the government’s currency, which is controlled by the government who can introduce more currencies into the economy to balance inflation and other parameters. As the traditional economies that run on government-regulated currencies display certain weaknesses that affect their value. Therefore, investors prefer to allocate more funds into bitcoins than traditional government-controlled cryptocurrencies.
Bitcoin’s Uncertain Intrinsic Value
The volatility of Bitcoin price is also dependent on its perceptive value and method of value transfer. According to theory, for fiat currencies their intrinsic value depends on the working methods of the government and the trust people have in the government. For Bitcoin, it is decentralized, not controlled by any government, and it is not backed by gold or silver, so some investors opine that it has no intrinsic value. The market perception for the value of bitcoins and other cryptocurrencies is that it has a specific method of value transfer and a store of value.
When an asset has a store of value, it means the asset maintains its value and can be sold after a short time at a predictable price. Method of value transfer means the value that is used to transmit the asset from one party to another. The volatility of Bitcoin makes its store of value uncertain, but it also means that the value transfer of the crypto asset can be done without any hassle.
Risks of being large currency holders
The volatility of Bitcoin is sometimes dependent on giant holders. These individuals or organizations hold huge proportions of the total of this digital currency floating in the Bitcoin market. It is not yet understood how the Bitcoin investors who have current savings of more than $10M would liquidate their position without disturbing the market in any way. The question is how the trading platforms liquidate their position in a small period.
Many cryptocurrency exchanges have withdrawal limits for 24 hours, which are quite below the limit. So for the large Bitcoin holders, they face the risks of erosion of funds if Bitcoin cannot achieve the market rates as perceived. Till now, Bitcoin has not touched the mass adoption prices, and when that rate is achieved, the large holders will get options trading value for their investments.
Breach of Security cause volatility
Bitcoin also becomes volatile when security vulnerabilities are exposed. In some cases, this produces huge responses of open source in the formation of security. The positive approach towards security services being used by exchanges and trading platforms produce excellent outcomes. There may be numerous significant open source initiatives of the software to its name like Linux. The creators of Bitcoin should inform the customers about security concerns so that there may be robust solutions.
The cause for the bankruptcy of Yapian Youbit was a hack. Numerous cryptocurrencies were stolen and hacked, and the exchange went for insolvency. This was headline news published by worldwide media. In April 2014, the vulnerabilities of OpenSSL were bombarded by the virus Heartbleed. This was announced by Google security’s Neel Mehta, who said that the event took the prices of Bitcoin reduced by 10% in a month.
Open-source developmental software and Bitcoin are created on a similar fundamental premise. An imprint of the source code can be examined by the users who are a part of this huge blockchain. This conception becomes the duty of society to voice matters about the design of the software. Society must take a consensus about alterations to the essential source code also. Many security breaches get highly publicized for the debate and open statements by crypto experts and promoters.
Fear Arising from High Profile Loss
Readers must know that the above-mentioned robberies and resulting news regarding the losses had a two-way effect on the market fluctuations. It diminished the total supply of Bitcoin and led to a potential rise in the value of remaining Bitcoin because of insufficiency in its supply. But overriding this rise was the negative effects of the following news cycle.
It must also be known that alternate Bitcoin pathways looked at the huge losses at the Mt. Gox as a large positive point towards the long-term usage and popularity of Bitcoin. It led to even more complications in the already complicated reasons that affected the fluctuations in the Bitcoin market. Since the adopting companies were annihilated from the Bitcoin blockchain because of dysfunctional processes and poor management, there have been entrants later on who have learned from their mistakes and built more solid processes to secure the network. It also strengthens the cryptocurrency market from all directions.
High Inflation Rates and Bitcoins
Some developing countries with high-inflation rates are using Bitcoins as that is advantageous for their economy. This is because the volatility of the digital currency is more versus the US dollar if compared with the high-inflation nation’s currency. For example, the bitcoin is highly volatile against the US dollar when compared with the Argentine peso against the USD.
In the case of Argentina, the easy transaction process of bitcoins gives it the potential as a good borrowing asset as the huge inflation currency loan, peso loans become costlier. The funders from other nations can benefit by earning a higher return by using bitcoins compared to other debt instruments that may be a risky proposition in the Argentinian economy because of the high inflation.
Tax Treatments Removes Volatility
The IRS considers Bitcoins as property for taxation purposes. All the income tax provisions generally applicable for properties apply to transactions that use the cryptocurrency. The individuals who sell Bitcoins must calculate the capital gain/loss on the sale and pay tax on the capital gains. This classification of bitcoin as an asset has both positive and negative impacts on the volatility of the crypto.
On the other hand, these directives issued by the taxation department, IRS, classifying Bitcoin as an asset had two negatives. One was for using Bitcoins as a mode of payment. The users found these tax laws complex as it involved recording the market price in each of the transactions they make. Then they have to keep a record of these transactions, even if it is small. Though such records need to be maintained for property or other assets, some users of Bitcoin may still find it complicated.
The second negative signal IRS’s decision gave to the digital currency market is these regulations may be amended to some stronger laws in the future. Some of the bitcoin analysts say that if higher controls are exercised by the IRS, it may slow down the adoption percentage of Bitcoin. This may stop the growing acceptance of bitcoins as an asset for investment, trading, and also for use as a mode of payment. The recent decisions of the IRS have received mixed responses from bitcoin investors.