Bitcoin Loses Over One-Fifth Of Value In Under 24 Hours—Why is Bitcoin so Volatile?
Reuters reports that Bitcoin lost over 20 percent of its value within the last 24 hours, sliding from Wednesday’s high of $11,395 down to a low of $9,000 in volatile trading on Thursday. Prices recovered slightly towards the end of the day, closing at $9,400 on the Luxembourg-based Bitstamp exchange.
Put within the broader context, this drop does not seem so dramatic: Bitcoin was up almost 1,100 percent year-to-date on Wednesday, and as of Thursday it was still up by 880 percent—big profits are still being made in Bitcoin, and will likely continue to be made.
However, investors should expect the volatility to continue.
The fact is that many of Bitcoin’s most recent investors—and many long-time fans of the cryptocurrency—have no idea what kind of investment they’re buying. This lack of knowledge, and its ramifications, is primarily why Bitcoin is so volatile, and why it will continue to be volatile.
What is Bitcoin? Why is it Volatile?
In understanding why Bitcoin’s so volatile, we must first understand exactly what Bitcoin is.
Bitcoin bills itself as a true digital currency, a medium of exchange with which people from around the world can buy and sell things—without the pesky, and sometimes expensive, mediation of banks. Its primary selling points are twofold:
1. The very nature of Blockchain technology ensures that Bitcoins can never be counterfeited, hacked, or stolen.
2. Bitcoins cannot be “printed” arbitrarily by a central bank like US Dollars or British Pound Sterling can, and it is therefore immune to the inflationary crises that plague fiat currencies. Furthermore, the number of Bitcoins that can ever be generated (by “mining” them using computing power) is finite—there is a maximum number of Bitcoins.
There are a number of other features which are touched on in the below video on Bitcoins. It’s short and worth the watch:
Essentially, Bitcoin works like digital gold: it can be used to settle debts, and it has a finite limit. But Bitcoin differs from gold in one key respect: it has no intrinsic value.
Gold is a tangible commodity that has useful properties. People love to look at gold and always have—gold jewelry is in perpetual demand. Beyond that, gold has valuable industrial applications as an electrical conductor. Computers, for example, use gold rather than copper in their chips because it conducts electricity far better.
Bitcoin, on the other hand, cannot be used for anything—it only has value because we ascribe it value. If no one accepted Bitcoins as a medium of exchange, or bought them as an investment, then Bitcoin would be literally worthless.
This is why calling Bitcoin a real currency, like gold, is a misleading. Bitcoin is a hybrid currency: it’s not quite fiat (because it has a limited supply), but it’s not real either (because it has no inherent value). Some have argued that Bitcoin does have an inherent value because it embodies the energy it took to “mine” the currency. But this argument is flawed because Bitcoin doesn’t actually store any value, ie. you can’t withdraw the energy used to produce Bitcoins (as you could with oil), nor do Bitcoins themselves have any practical application (like gold).
The value of Bitcoin is derived purely from trust and speculation—as with any other fiat currency that one might trade on Forex.
Why is Bitcoin Volatile?
This brings us to the question of volatility: Bitcoin is volatile because people are now buying it with the expectation that it will continue to increase in value. They’re treating it as an investment rather than a currency. And frankly, they’re right to do so.
Bitcoin isn’t a currency, and hasn’t been one since 2014 when the Internal Revenue Service deemed Bitcoin to be an asset rather than a currency with Notice 2014-21. Ergo, every time a Bitcoin changes hands a capital gains disposition is triggered for US tax purposes—the same thing happens whenever someone sells a stock or a house. This means that Bitcoin (in the US at least) cannot function as a currency. Bitcoin is an asset.
Many people don’t know this, and they will be sorely disappointed when the Internal Revenue Service audits them next year. And those that do know are now bidding up Bitcoin’s price with the intention of flipping it for a profit, as they would any other non-yielding asset.
For this reason, Bitcoin will only grow more volatile over time—once the penny-flippers find something they like, they will bleed it dry. This happens every day on Canada’s notorious Venture (vulture) Exchange—speculators and pumpers drive up prices and dump their stock before the turkeys realize they just bought thin air. This is Bitcoin’s future.
There is good evidence that this will be the case: according to Blockchain.info, one of the world’s biggest Bitcoin wallet-providers, over 100,000 new customers signed up on this Tuesday alone. These people see Bitcoin as an investment, not a currency, and will contribute to ongoing volatility in the cryptocurrency.
Bitcoin’s not the “sure thing” many people think it is—Bitcoin is volatile, and it will only get worse as more vultures smell blood.