If you are a financial analyst, there is probably one feature to Bitcoin that stands out above all the others.
It’s not decentralization.
It’s not censorship resistance.
It’s not blockchain.
No, the feature some investors love most about Bitcoin has nothing to do with its tech.
What they love about Bitcoin is its price volatility. That’s because big risk can mean big rewards.
But why is Bitcoin, historically speaking, so volatile?
Let’s find out.
There is a simple way answer to this question: supply and demand.
There are times where lots of people want to buy Bitcoin and not many people want to sell it.
When that happens, the price goes up quickly.
Then there are times where lots of people want to sell Bitcoin and not many people want to buy it.
When that happens, the price goes down quickly.
This is the answer for why any good changes price. And the speed of that change in price is relative to how quickly the numbers of buyers and sellers change.
But this is a very unsatisfying answer to most people.
Of course, if you have lots of buyers and few sellers, the price will go up.
What you really want to know is WHY there are lots of buyers and few sellers (or visa versa).
And…why do the numbers or buyers and sellers flip so quickly in the Bitcoin market?
Like any complex market, there are many potential variables that affect the current price, and it’s impossible to ever know the exact reasons for any price movement in particular.
What we can do is think about some general causes for these price changes that may be at play at any given time.
let’s talk about some of those.
NOTE: One thing you might notice about the causes mentioned below is that they are not "either/or". For instance a market event that affects the price could fall into more than one category below.
The Bitcoin project is still fairly new (only about 14 years old now), and upgrades to the network are continually rolling out.
As Bitcoin’s tech evolves, some investors may become more confident in Bitcoin’s potential and drive up demand for the asset.
But a tech upgrade could also cause the price to drop.
For instance, if Bitcoin clients were to roll out an upgrade that had a critical bug that broke Bitcoin’s core appeal, you could imagine the price taking a hit.
This actually happened in 2010, when a Bitcoin Core developer realized that a single transaction ‘created 184,467,440,737.09551616 bitcoins for three different addresses.”
The creation of this many bitcoins obviously violates Bitcoin’s rule that only 21,000,000 coins can ever be created, so this was clearly a bug and split the chain.
Technological changes always have some level of uncertainty and risk to them, and for that reason, their rollout (or lack thereof) affects price.
General market conditions play a significant role in influencing the price of Bitcoin, just as they do with traditional financial assets.
The financial markets are interconnected, and changes in one market can have ripple effects on others.
One key general market condition that impacts Bitcoin is monetary policy, especially policies enacted by influential central banks like the Federal Reserve (Fed) in the United States.
When the Fed changes its policy stance, such as raising interest rates, it affects the liquidity and the cost of borrowing money in the market.
When interest rates increase, it becomes more expensive to borrow money, which can lead to decreased investment and spending, resulting in price drops for those assets.
The Phemex Exchange blog already did a great writeup on the topic of the Fed Funds Rate’s effect on Bitcoin’s price if you want to know more.
As Bitcoin and other cryptocurrencies gain popularity, governments worldwide are grappling with the question of how to regulate them.
In some cases, governments have sought to ban or impose strict regulations on Bitcoin, causing a decline in it’s price..
These regulations scare off investors in the short term, putting downward pressure on price.
But regulatory news can go the other direction as well.
When a country adopts a more favorable regulatory stance, it can lead to increased adoption and demand.
News like this is bullish for Bitcoin’s price and makes investors feel safer about purchasing and holding Bitcoin.
Bitcoin is no longer the only player in the cryptocurrency market.
With the emergence of numerous alternative cryptocurrencies, or “altcoins,” Bitcoin faces increased competition.
When a new cryptocurrency gains traction and attracts investors (usually through large marketing budgets and grand promises of unheard of returns), it can divert some of the demand away from Bitcoin, causing the price to decline.
When those coins almost inevitably disappoint due to over-promising and under-delivering, Bitcoin attracts that investment back and experiences a surge in price.
Competing projects tend to both raise money and collapse very quickly, which also makes the investments in and out of Bitcoin happen quickly, resulting in volatility.
Market manipulation can take various forms, such as “pump and dump” schemes or “spoofing” where large buy or sell orders are placed to create a false impression of demand or supply.
Market Manipulation is a bit of an older factor on the price of Bitcoin.
Because the Bitcoin market is so large, with a daily trading volume of about $11B USD, these days it is very hard to manipulate the market.
However, in the early days it was much easier.
Today, you tend to see this behavior happening on smaller altcoins, most notably with the popular Mango Markets chain.
“Avraham Eisenberg, 27, was charged with fraudulently obtaining about $110 million worth of cryptocurrency from the digital asset exchange Mango Markets through artificially manipulating the price of specific perpetual futures contracts, or financial agreements that require the buying or selling of an asset at a particular point in the future.”
Bitcoin’s price swings are not mysterious.
They are the result of market forces just like any other asset price.
What makes Bitcoin’s swings so much more intense are the fact this it is a (relatively) new technology that is controversial and largely unregulated.