Is Bitcoin's Volatility Such a Bad Thing?

Highly volatile asset class

One reason why traditional investors have shunned Bitcoin is that its price has swung from one extreme to another. Its price increased from around $1,000 at the beginning of the year to a peak of over $5,000 in September 2017 (gain of +400 percent), before crashing to a low of $3,000 (-40 percent from its peak). Even this represents an improvement from the initial days when Bitcoin price crashed from $32 to $2 in 2011 (a drop of 94 percent). There have been periods of low volatility, but these have been few and far between. Bitcoin may be called digital gold, but in terms of volatility, it looks more like stock markets on steroids.

Volatility is an opportunity for traders

For day traders and short-term investors, volatility presents an opportunity for making profits. By correctly predicting the short-term trends in Bitcoin, traders can make substantial profits; much more than investors who have a buy-and-hold strategy.

Highly volatile markets also create demand for secondary derivative products like options.

As the cryptocurrency market develops, we could see increased trading of derivative products rather than actual trading of Bitcoin.

As per the London Bullion Markets Association, it is estimated that 95 percent of gold trading in London is in unallocated metal (which is not settled). Bitcoin is still in its infancy, but as the market develops we could see the same trading characteristics in Bitcoin as well.

Bane for merchants

Merchants, no matter how tech-savvy they are, hesitate to accept Bitcoins for their goods and services. Their core competence lies in providing goods and services, not in managing Bitcoin's volatility.

They work on thin margins and hate even the one to two percent transaction fees imposed by credit card companies.

The Bitcoin price can move substantially between the time they accept Bitcoins from customers, and they sell these Bitcoins in exchange for their local currency. This price movement can wipe out their entire profitability.

This is the reason why most merchants accept Bitcoin only through payment processors like Coinbase, which removes the risk associated with holding Bitcoins. In the end, merchants have to pay their bills using fiat currencies, not Bitcoin.

Volatility inevitable during growth

Bitcoin is a relatively new asset class. Although the level of awareness about Bitcoin among the general population has increased, only a small proportion of them hold significant amount of Bitcoins.

Moreover, institutional investors have largely avoided Bitcoin, given its unregulated nature and the risks associated with it.

As Bitcoin adoption increases and demand increases, its price can move up rapidly.

Similarly, when there is negative news about Bitcoin, like the Chinese shutting down cryptocurrency exchanges, some of the holders of Bitcoin will sell and its price can crash rapidly.

Until the holding of Bitcoin becomes widely distributed and its liquidity improves substantially, we will see substantial volatility in Bitcoin price.