Bitcoin Volatility: What Causes Cryptocurrency to Rise and Fall?

Bitcoin is a cryptocurrency that rises and falls in value just like traditional currencies. Unlike established national currencies, which usually trade in a specific price range and rise and fall in value slowly, Bitcoin prices are volatile.

Volatility is the measure of price change within a specific time frame. High volatility means the price can change dramatically in a short period. Low-volatility currencies usually remain within a narrow price range and experience small, slow price changes.

In currency markets, traders use statistical tools, like the standard deviation, to measure how much the price moves from its average throughout a specific period. The further away from average an asset moves, the more volatile it is. Speculation, a lack of regulation, and other factors make Bitcoin up to 10 times more volatile than major exchange rates such as the dollar.

Here is a closer look at the volatility of Bitcoin, the factors that cause it, and how it affects you when you trade the cryptocurrency.

Causes of Bitcoin Price Volatility

Several key factors are responsible for Bitcoin's price fluctuations. These include external influences like regulatory changes and geopolitical events. Though they occur outside of Bitcoin trading markets, these factors still impact the price.

Issues within the market itself also cause price movements. These include market sentiment, large trades by investors, or changes in supply and demand.

Market Demand and Supply

Like all financial markets, Bitcoin is affected by supply and demand. Prices rise when demand exceeds supply and fall alongside weakening demand.

Bitcoin miners, who provide computing power to process Bitcoin transactions, are awarded with new bitcoins. However, the creation of these new coins is a slow and steady process. Mining does not create enough bitcoin to meet significant demand spikes, leading to price increases as buyers compete for the limited supply.

Regulatory News and Government Actions

Regulatory changes can have a significant impact on Bitcoin prices. Negative news, such as increased taxation or new regulations, can cause a selloff that could lead to a Bitcoin market crash. This happened in 2013 when China banned Bitcoin transactions, causing the currency to lose 50% of its value in a matter of hours.

On the other hand, positive news, such as a country licensing new Bitcoin exchanges, can increase both confidence and prices as investors look to take advantage of this new market access.

Bitcoin investors want to avoid holding the cryptocurrency when new regulations cause a price drop. They will sometimes try to dump the currency based on rumors of coming rule changes in the news, even if these law changes never occur.

Media Influence and Public Perception

Media coverage plays a significant role in driving Bitcoin prices up or down. Positive news stories, such as the launching of exchange-traded funds based on Bitcoin, can lead to increased public interest and trust, getting more people to buy crypto. This new demand can cause a price increase.

On the other hand, prices can fall with reports of controversies, as happened with the collapse of a major cryptocurrency exchange called FTX, whose founder ended up being prosecuted and jailed for fraud.

Social media also impacts Bitcoin's price movements. High-profile endorsements or critiques from celebrities can change market sentiment. This happened in 2019 when Elon Musk hyped Dogecoin, a relatively unknown cryptocurrency, causing it to increase in value significantly.

Technological Developments

Technological advances, such as improvements in security protocols, lead to increased investor confidence and can drive prices higher. On the other hand, technological issues or vulnerabilities can have a negative effect on Bitcoin prices. News of bugs, security breaches, or failed upgrades can lead to market instability.

For instance, blockchain improvements to make processing transactions more efficient and secure could increase confidence and, in turn, demand for Bitcoin.

Market Manipulation

Because of global access and lack of universal regulations, crypto markets are prone to manipulation. One common tactic is the "pump and dump" strategy. Bad actors artificially inflate the price of Bitcoin through coordinated buying. They create fake demand and then watch as the market responds to it by increasing prices.

Another manipulation tactic involves spreading false rumors to sway market sentiment. Manipulators release fake information and take a position in the market to capitalize when the price rises or falls in response to their made-up reports.

Effects of Bitcoin Price Volatility

The volatility of Bitcoin can be both a positive and a negative. Price fluctuations can create opportunities for traders and investors to profit if they can predict market moves. On the other hand, volatility can also lead to financial losses and make buy-and-hold investing risky.

The impact of volatility goes beyond risks and rewards. Here is a closer look at the effects of Bitcoin volatility.

Impact on Investors

Individual investors may find managing risk challenging as prices fluctuate. In such situations, you have to decide if you should hold and wait for a market correction or if you need to exit and take a financial loss before you lose your entire investment.

Institutional investors need to weigh the potential profits from having Bitcoin in investment portfolios with the risks of sudden price drops, which are difficult to hedge against due to the fact that other cryptocurrencies often move along with Bitcoin.

In both cases, the volatility can complicate long-term planning and risk management.

Influence on Other Crypto Market Volatility

As the most prominent cryptocurrency, Bitcoin often sets the tone for different crypto markets. Significant price swings in Bitcoin can lead to similar moves in other markets, like Ethereum.

This is because investors look to Bitcoin to measure the overall state of the crypto industry. Because of this phenomenon, Bitcoin's volatility can make smaller coins more volatile even though there are no other factors causing their volatility.

Implications for Adoption and Usage

Bitcoin's volatility sometimes hampers efforts to adopt cryptocurrencies for payments and other uses besides speculation. For retailers, for example, the risk of price swings can make accepting Bitcoin less attractive.

Also, Bitcoin’s volatility can make it a poor long-term investment. Some investors use it as a hedge against inflation, but many prefer less volatile investments like gold for this purpose.

If you use Bitcoin as a store of value or a currency, you need to figure out how to mitigate volatility.

Strategies To Mitigate Bitcoin Price Volatility

Investors can employ well-known financial strategies to manage the risks associated with Bitcoin price volatility. Here are the most prominent risk management examples.

• Diversify investments across various assets. Find investments that increase in value when Bitcoin prices decrease to cancel out some or all of your crypto losses.
• Use trading orders, such as stop-loss orders, when trading on Bitcoin exchanges. Stops automatically sell your bitcoin when the price reaches are certain level, automatically capping losses before they become too severe.
• Balance your portfolio so that you have capital for long-term investments and speculative investments like Bitcoin. With this approach, you won't lose your entire savings speculating on Bitcoin.

Understanding Bitcoin price volatility is crucial for all crypto investors. If you know the factors that drive volatility, you can be aware of potential problems and take steps to limit your risk.