Why Bitcoin’s Price Fluctuates So Much
If bitcoin were simply a currency, then it would be a lot more stable than it is. The price of a currency is always relative to other currencies, and these changes in price are a matter of changing supply and demand of bitcoin regardless of the reason it is purchased or sold.
If buyers and sellers just bought and sold bitcoin for transactional purposes, in other words for its use as a currency, while we may expect the price to rise in accordance with the growing popularity of bitcoin as a payment method, bitcoin simply hasn’t grown all that much for this purpose.
The demand for bitcoin as a currency would also be quite stable, where its use for this purpose would normally fluctuate somewhat but this effect would be minimal compared to what we have seen with the way bitcoin’s price moves around in practice.
As the currency matures and becomes used more, the larger market capitalization would serve to stabilize it. As more and more people use it, the differences in use day to day and over any period would normalize, further reducing these fluctuations in price.
While bitcoin is indeed growing in popularity as a currency, albeit at a fairly slow pace, this is not really at the point where it can serve as much of a stabilizing force, at least not yet.
However, the big move away from speculating on bitcoin that we have seen since it has stopped just going up in value and has gone through a major correction has served to cool things down quite a bit, and this is the real reason why we have seen bitcoin become more stable lately.
When so many people flock to an investment as we saw with bitcoin, this can really drive the price of it up, much like the price of tulips were driven up in the Netherlands in the 17th Century. While we could say that the demand exceeding the supply is what drives the price of anything up, in the case of both Dutch tulips and bitcoin, a lack of any real ceiling on the prices was the main driver of this mania.
We see this to some extent with some other types of investments, precious metals for example, where the price that it is traded can well exceed its intrinsic value. These rises are generally tempered by historical data though, for instance we can look back on the price of gold and wonder whether or not a certain level can be sustained for long.
Other investors use this past data as a guide as well, and if the price rises to historically uncomfortable levels, this can cause many investors to exit their positions in fear of a pullback. This of course serves to put downward pressure on it, and when this builds up enough, we do indeed see the pullback that people were afraid of.
Other assets, like stocks, bonds, and futures, see their price limited by intrinsic valuations, for instance, earnings with stocks, interest rates with bonds, and what end users are willing to pay with futures.
With bitcoin, as well as with Dutch tulips, as they rose all the way to the sky, they had no real reference point at all. The limits to how high they could go was only limited to how much money that investors were willing to commit to them, and this number, as it turned out, was a pretty big one indeed
All the trading activity that was driven by speculation is what really caused bitcoin to both fluctuate so wildly and to go up so much, and the craze that emerged did manage to have it moving a lot, where its price even by the hour could vary very significantly.
The more money that is put into bitcoin in order to speculate on it, the wider the fluctuations in price will be. Bitcoin has attracted a wide section of the public during this time, from savvy traders to everyday folks who aren’t really the sort to speculate on anything but simply found bitcoin to be too tempting to resist.
Bitcoin’s New Investment Landscape
In late 2017, the reality that bitcoin could not keep going up forever finally set in. We went from an investment that was seen as being in a huge boom phase to one that was far from that, as the price dropped dramatically over the next few months.
Investors are naturally a lot more hesitant to jump in the same way that they did during the rise of bitcoin, and with good reason, as the landscape is much harder to navigate these days.
Bitcoin has become much more of a trader’s asset than an investor’s one these days, at least at the present time anyway, in August 2018. Bitcoin has established somewhat of a floor now, and does move pretty significantly percentage wise, but is still bound in a range.
Many people predicted that the fall of bitcoin would be a lot more dramatic than it has been, or has been at least so far, but the same frenzy that drove it up so much wasn’t quite at the same level on its pullback. While it did end up giving back over half its value at its peak, this magnitude isn’t that remarkable for a bear market generally, and we for instance saw an even greater pullback in the stock market during the bear market of 2007-2009.
The difference with bitcoin though was the speed in which the pullback materialized, occurring over just 3 months. Bitcoin isn’t known for its gradual movements to be sure though, and therefore this wasn’t surprising. Those who were looking to panic or to take profits didn’t waste any time doing so, and while this sort of abrupt movement is the sort of thing that can precipitate much bigger and much longer bear markets, bitcoin has managed to maintain the level of support that it ended up bouncing off of thus far.
Given how much bitcoin did run up over time, and especially after the massive rise during the previous few months, it’s actually quite remarkable that bitcoin only pulled back by the amount that it did, and this does show that bitcoin as a lot more resilience than many had believed.
All those who entered prior to October 2017 and have held on to their positions are still up though, and depending on how far back before this it was bought, many are still up by phenomenal amounts.
The people who didn’t get scared out of their positions by the big pullback that we’ve seen already aren’t going to be shook out very easily, and this actually adds stability to bitcoin’s price, as opposed to when a lot of people held it who were more easily swayed.
While stability isn’t necessarily a good thing, and the fact that bitcoin attracted the massive degree of speculation that it did is testimony to just how much speculators love volatility, especially the upward kind, there are certainly some benefits to bitcoin not fluctuating so wildly.
More stability would certainly help bitcoin grow as a means of exchange, a currency, which is what its main function was supposed to be prior to it being madly popular as an investment. The more stable a currency is, the better it functions as a means of exchange, and while it has a long way to go to get anywhere close to the stability of traditional currencies, it is at least headed in that direction more now as a result of so many speculators getting shaken out by the pullback.
Moving from a period where a lot was unknown about where bitcoin might go, with predictions varying from it increasing many times over what it actually achieved to it dropping to virtually zero, we now have some history to fall back on, and history that was driven by what are clearly extremes, tulip style mania followed by tulip style panic.
Unlike the Dutch tulips though, bitcoin has shown that it can go through an event like that and survive it, and probably even continue to flourish. The glory days may be over, or not, and perhaps one day we may even see it surpass its all-time highs and break new ground, but probably not in as dramatic fashion as its original very dramatic rise.
Bitcoin should continue to stabilize more and more as time goes on. Nothing with bitcoin or any cybercurrency can be known with any great degree of certainty, but we are at least pointed in this direction more now.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.
