Why Is Bitcoin Volatile?

Bitcoin, made publicly available in 2009, began its rise to popularity around 2010 when the price for one token rose from fractions of a dollar to $0.09. Since then, its price has increased by tens of thousands of dollars—sometimes rising or falling thousands of dollars within days.

There are several reasons why Bitcoin has such a volatile price history. Understanding the factors that influence its market price can help you decide whether to invest in it, trade it, or continue watching its developments.

Bitcoin Supply and Demand

Supply and demand influence the prices of most commodities more than any other factor. Bitcoin's market value is primarily affected by how many coins are in circulation and how much people are willing to pay. By design, the cryptocurrency is limited to 21 million coins—the closer the circulating supply gets to this limit, the higher prices are likely to climb.

It is difficult to predict what will happen to prices when the limit is reached; there will no longer be any profit from mining Bitcoin. As big financial players compete for ownership in an environment of dwindling supply, Bitcoin's price will likely fluctuate in response to any actions they take.

Bitcoin Investor Actions

As the most popular cryptocurrency, Bitcoin demand increases because supply is becoming more limited. Long-term, wealthier investors hold their Bitcoins, preventing those with fewer assets from gaining exposure. According to the National Bureau of Economic Research, one-third of all Bitcoins were held by the top 10,000 investors at the end of 2020. Brokers and other financial institutions are working desperately to get approval from the Securities and Exchange Commission for Bitcoin-backed securities—the number held by institutions and large investors will continue to rise as more securities are designed.

Bitcoin volatility is also driven, to an extent, by these investors. It is unclear how Bitcoin whales—investors with BTC holdings in the tens of millions or more—would liquidate their significant positions into fiat currency without affecting Bitcoin's market price. If the whales were to begin selling their Bitcoin holdings suddenly, prices would plummet as other investors panicked as well.

Most exchanges have limits on the amount that can be liquidated in one day, in the range of around $50,000. Investors with thousands of Bitcoin may not be able to liquidate their assets fast enough to prevent enormous losses. If Bitcoin prices continue to hover around $50,000, a larger investor could only liquidate one coin per day. Other investors would begin to sell, and prices would plummet before anyone with more than $50,000 in coins could sell them all off, leading to large and rapid losses.

Bitcoin volatility is also partly driven by the varying belief in its utility as a store of value and method of value transfer. A store of value is an asset's function that allows it to maintain value in the future with some degree of predictability. Many investors believe that Bitcoin will retain its value and continue growing, using it as a hedge against inflation and an alternative to traditional value stores like gold or other metals.

Bitcoin in the News

Because news and media outlets are businesses that need content for their readers and viewers, they often present information and predictions from "experts" that are not always verified by evidence other than opinions.

It's not uncommon to hear an opinion from someone heavily invested in Bitcoin stating that the currency will soon be worth hundreds of thousands. Others hype newly invented cryptocurrencies to try and take away market share from Bitcoin. However, most of this media attention and publicity serves to influence Bitcoin's price to benefit the people who hold large numbers of coins.

When media outlets announced Proshare's introduction of its Bitcoin Strategy ETF (exchange-traded fund) in late October 2021, Bitcoin's price skyrocketed over the next few weeks. Investors jumped at the chance to gain exposure to a cryptocurrency on an official exchange, causing a price jump to more than $69,000.

After the hype died down and investors realized the ETF was linked to Bitcoin through futures contracts traded on the commodities market, prices dropped back down around $50,000.

Bitcoin Regulation

Rumors about regulations tend to impact Bitcoin's price in the short term, but the significance of the impacts is still being analyzed and debated.

Government agency views of cryptocurrency can also affect Bitcoin's price. For example, the Internal Revenue Service (IRS) considers Bitcoin a convertible virtual currency because you can convert it to cash. The IRS also considers Bitcoin a capital asset if it's used as an investment instrument. Additionally, if you mine a Bitcoin, you are required to report it as income based on the coin's market value on the date you receive it.

China's government and central bank announced in 2021 that all cryptocurrency transactions or facilitation were illegal. Bitcoin mining was cracked down upon following a meeting of the State Council Financial Stability and Development Committee in May, which resulted in a massive shutdown of cryptocurrency mining farms in the country. Rumors of the push to end mining in the country had caused prices to drop previously—but following the release of the committee meeting in May, Bitcoin's price dropped through August 2021 to around $29,700 as miners scrambled to relocate.

Bitcoin Is Still in Its Infancy

As a means of exchange, gold has been used for a very long time. As such, it is a reasonably stable commodity, as far as price, demand, and supply go. Likewise, fiat currency has been around for some time—while exchange rates between countries fluctuate and are somewhat volatile, their values are to a point predictable based on the issuing country and the economic circumstances it faces.

Bitcoin has only been around for a short time—it is still in the price discovery phase. This means that prices will continue to change as investors, users, and governments work through the initial growing pains and concerns until prices stabilize—if a stable point can be reached.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author does not own cryptocurrency.