Why Is Bitcoin Volatile?
Bitcoin prices are not known for their stability, which is odd, considering that the currency’s end goal is to “replace fiat money.” That goal is likely to go unfulfilled if Bitcoin volatility remains this high, because no one holds onto cash that can drop 10% in a single day.
If you are unfamiliar with Bitcoin prices, then you probably think there is no rhyme or reason to the current volatility. The cryptocurrency websites don’t help either. They just keep using words like “Segwit2x” and “USAF” as if everyone is supposed to understand them.
None of their (hundreds of) articles include a Bitcoin price prediction.
It is all very confusing. But this confusion is unnecessary—the answers are well-known in the Bitcoin community. But because most of the community is used to communicating in shorthand, they have trouble translating for non-experts.
I’ve put together a list of three factors affecting the price of Bitcoin. Hopefully I avoided too much jargon, but I’ll let you be the judge of that.
1. An Experiment to Speed Up Bitcoin Transactions
Transferring Bitcoin sounds great in theory, but as more and more people start to send money, there are real-world problems that arise. One of them is speed.
Under the current regime, Bitcoin transactions take forever and a day (or two hours, which is just as bad). To put this in perspective, imagine having to wait two hours at KFC.
You might be willing to sit around for fine dining, but not for fast food.
Likewise, Bitcoin is supposed make payments easier. It promised quick, painless solutions, yet the network is often choked by excessive volume.
In order to resolve this issue, some members of the community want to pack more data into each “block.” This is what people mean when they refer to “Segwit.”
But it’s important to remember that Bitcoin has no President or CEO—it functions as a democracy. Except in this Democracy of Bitcoin, there needs to be at least 95% agreement before SegWit becomes the law of the land.
At present, it’s just a theory. Hence the violent cha-cha in Bitcoin prices starting around the end of May.
Chart courtesy of CoinDesk.com
2. Big Money Is Moving Between Bitcoin and Other Cryptocurrencies
Have you heard of Ethereum? What about Ripple? Litecoin? Dash? Monero?
These are imitations that claim to have improved on the core concepts in Bitcoin. But in order to buy most of these cryptocurrencies, you still have to go through Bitcoin first.
Here’s how it works: You buy Bitcoin, convert it to Ether (the currency of Ethereum), then convert Ether into some other token. The volume of these transactions has risen sharply in recent months, because of a phenomenon called “initial coin offerings.”
In a nutshell, these “ICOs” help companies raise money. For instance, if you want to launch a startup that uses some technology in Bitcoin—but with your own digital currency instead of Bitcoin—you can issue a “token” for people to buy.
It’s basically the same thing as issuing new shares, except you don’t give up any ownership. The buyers don’t get equity in your company. What they get is a right to use those tokens to buy your product sometime in the future.
But in order to buy these tokens, they have to pass through Bitcoin and/or Ethereum. And since these transactions are often gigantic, they can swing Bitcoin prices in one direction or the other.
3. Plain Old Fear
Earlier this month, hackers stole data and money from one of the largest Bitcoin exchanges in the world. Nearly 32,000 customers of the Bithumb exchange were affected, at least that is according to a South Korean news wire service.
This isn’t the first time that hackers stole Bitcoin from an exchange. It is pretty much impossible to hack a Bitcoin in transit, but exchanges have proved vulnerable. Of course that is going to scare off some investors.
If you were burned by theft, of course you would feel reluctant to hop back in. It’s human nature.
That said, this particular hack happened because the hackers infiltrated a personal computer belonging to one of the people who worked at Bithumb. It’s not like the exchange itself was hacked.
But the fact remains that Bitcoin is new, and new can be scary.
Should You Be Scared of Bitcoin Volatility?
Consider your risk tolerance before investing in Bitcoin. If you are someone who likes knowing exactly how much money is in their trading portfolio, maybe this investment isn’t for you. The volatility is far from over, you see.
But if you can truly handle the perils of high-risk investing, then maybe you won’t mind seeing a 10% drop. (So long as there is a 20% jump to make up for it, of course!)
For my part, I don’t see this as a plateau for Bitcoin. I believe we’re in the first inning of the cryptocurrency market, during which volatility is the baseline assumption.
So even if the ride is shaky, I still believe the road leads up.