Understanding Bitcoin's volatility

Bitcoin has long been known for its somewhat wild price action, making massive gains and subsequently taking huge hits. Believe me, we Bitcoiners realize this; the traditional finance community is sure to remind us at every opportunity.

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Let’s briefly explore a few reasons why these swings happen.

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Small Market Cap

Today, Bitcoin has a rather small market cap when compared to other assets, sitting at roughly $1 trillion, versus more mature categories like bonds (~$300T), real estate ($300T), equities ($~100T), and gold ($15T). That is, the total dollar value of all outstanding Bitcoin is much less than these other asset types.

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As Robert Breedlove so aptly describes it (start at 2:20 in this video), an asset with a small market cap is something like a small boat on a massive sea, more easily tossed about by the waves (e.g., macro economic, regulatory, and other evolving conditions) than much larger vessels.

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As Bitcoin’s market cap grows, these variables will be less consequential to its dollar-denominated value.

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Early Adoption

Tied very closely to Bitcoin’s relatively small market cap is the reality that we are still very early in global adoption. Perhaps just 1% or 2% of the world’s population hold any Bitcoin.

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And a small percentage of those people have actually taken time to really understand the technology and its implications in a meaningful way.

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Therefore, we still see a lot of speculators (versus long-term holders with high conviction) in the market when the dollar price of Bitcoin runs up. These people are then quick to sell and take a profit forcing downward pressure on price once it reaches a peak.

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While the upside for Bitcoin remains massive, over time the upward swings will likely ease a bit and make it less lucrative (say, a 30% move up versus historic moves of 100%+) for some participants.

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Additionally, more people over time will be forced into Bitcoin as the consequences of central banking play out. These individuals will not enter for short-term gain, but rather long-term preservation of purchasing power, a plan B, or other sovereignty-related reasons. Others will passively invest with a longer time horizon through vehicles like ETFs, much as people have long invested in index funds.

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For most other smaller asset classes, such as silver (also a ~$1 trillion market), there is already an established history and larger “user base” that mitigates against much of the volatility that we see with Bitcoin.

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In short, higher rates of non-speculative adoption will mean more long-term holding and less volatility.

Fewer Scams

Two years back, we witnessed the collapse of Celsius, BlockFi, FTX, and others who were forced to sell Bitcoin to cover their scams or short-sighted, opportunistic business models. This sell pressure led to a large drop in Bitcoin’s price as supply and demand dynamics worked themselves out.

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Bitcoin was (and often is) mistakenly conflated with these scammy crypto companies and projects, and also took a reputational hit. Once Bitcoin is more widely understood and recognized as distinct from “crypto,” it won’t be so adversely effected by scammers, and scammers won’t gain so much traction to begin with.

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As you consider Bitcoin’s volatility, it is also important to remember that “volatility” and “risk” are not synonymous, though they are often spoken of as such.

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There is certainly a non-zero chance that Bitcoin doesn’t play the enormous role in the global monetary order that us bulls believe it will.

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But there is also a non-zero chance, and I’d argue a very high chance, that the US government will either default on its debt (unlikely) or print trillions of dollars to pay bond holders with money that it doesn’t have (very likely, in my opinion) which would lead to massive price inflation (i.e., bond holders get paid what they are due in nominal terms but are crushed in real terms). Having an allocation to something that can’t be printed by central bankers (e.g., Bitcoin) would probably be a good thing in that kind of scenario.

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The point is that while bonds may not be volatile, they don’t come without risk, whether in the form of a hard default (actual default) or soft default (returns get crushed by inflation).

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The reasons most Bitcoiners remain unfazed by Bitcoin’s volatility are that 1) Bitcoin’s fundamentals are still in place, 2) it is only a matter of time, we believe, before we face a sovereign debt crisis, and 3) when that day comes, we’ll want something completely detached from the system.

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In the meantime, we’re happy waiting out Bitcoin’s crazy volatility and holding on for the long term.