Why is Bitcoin so volatile?

On my phone, I get alerts whenever something is on the move in the financial world. Nothing alerts me more often than cryptocurrency. The most common message I get is “ETH has fallen 5% in the past 12 hours.” Sometimes it will have risen 5%, and sometimes it will have fallen 5%, but the point is, if it is a big move in a short time, it's most likely a cryptocurrency.

The wildly fluctuating price of crypto hinders its usefulness as a form of payment. Who would want to accept payment in something that has its value changing so fast? Can you imagine trying to keep your books in bitcoin instead of your home currency? Your month-over-month change in financials would be a nightmare, simply because of the fluctuating value of the underlying currency. 

It is often suggested that volatility will decrease as bitcoin grows, but that hasn't been the case so far. Bitcoin can grow either via trading volume, or by price. We don’t think size matters so much. Case in point, the total value of all bitcoin exceeded $1.15 trillion in October, before losing almost 70% just this year. While it is true that the US dollar has lost value to inflation this year, the repercussions of having last year's $100 bill be worth just $30 today, are hard to fathom.

Bitcoin's wild ride limits its usefulness

So what gives? Why is crypto so volatile? Is it a feature? Or a bug? Let’s unwrap the economics of price stability a little. For that, let’s take a look at an industrial commodity that is used to manufacture things. For this illustration, we'll use copper. Plumbing, wiring and even new EVs all use copper. Further, each of those items has a market price. Going into the market price of each of those items are the cost of the ingredients, which include copper.

This is where it gets interesting. If the price of copper fell, it would provide an incentive for manufacturers to increase production because their profit margins have increased. On the other hand, if it rose, factories would be incentivized to either cut back on production, or even switch to the next best thing besides copper. With copper as an ingredient in so many things, its price can only rise so far before users do not have an economic benefit from its use.

So a rising price will reduce demand, but it will also incentivize production. With supply increasing and demand decreasing, the price is brought back into balance. On the other hand, If the price declines, producers will have a reduced incentive to produce, again naturally balancing out supply and demand.

As you can see, copper and other commodities are intricately tied into the economy. They have a natural moderating force of supply and demand keeping their price relatively stable. This is the way with all commodities. They are woven into society so their price is influenced by the price of other things, with each thing having a moderating force on the final price.

Bitcoin and other alternative cryptocurrencies have no such force. While it is true that producing a new bitcoin uses electricity, bitcoin was designed to be produced at a steady pace. If the cost of electricity rises, fewer miners compete to win payment, but the pace of production doesn’t necessarily change. That means just as many bitcoins are being produced at $50,000 as there is at $20,000 per coin.

With the supply coming at a steady rate, it becomes the speculator that determines the ultimate price for cryptocurrency, and not the producer. For commodities such as copper, the price is determined by the marginal user. For bitcoin, the price is determined by the marginal speculator. It is a big difference, because it allows the price of bitcoin to fluctuate much more than other commodities.

We don't mean to imply crypto isn't useful. It's just that its usefulness as an alternative form of money is currently limited due to its extreme volatility. On the other hand, the extreme volatility has made crypto a favorite among speculators who look for large price movements in order to profit. As is often the case, what started out as one thing, morphed into something else entirely. As its usefulness evolves, so will its price.

As long as bitcoin's price fluctuates as much as it does, it will not replace the almighty dollar as the worlds reserve currency. And the way bitcoin is set up assures that its price will continue to fluctuate. As long as that is the case, it will continue to be a useful tool for speculation, but have limited usefulness as a form of money.

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I've been trading and traveling my entire adult life. I'm currently trading from my boat in the Caribbean. Over the years this has gotten easier and easier to do. Drop the anchor, tether your phone to your laptop, browse some charts, and trade. At Wanderer we first began investing in Bitcoin in 2017 when it was worth $2,500. Fortunately, we recognized its potential, unfortunately, we didn't realize it even earlier. Today it is worth about $50,000, and we believe it is here to stay. Bitcoin will have its ups and downs along the way, but years from now we expect it will be much higher, and we'll still be bopping around in the islands.

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