Bitcoin’s history of volatility is legendary with periods during late 2013 where there were daily changes of over 40% in either direction. However, since that time Bitcoin’s volatility has gradually decreased to the point where now it is at an all time low and more comparable to other assets such as Gold.
The Canadian Bitcoin Volatility Index (CBVIX) records the 30-day historical volatility using daily closing prices calculated from a volume-weighted calculation of all Bitcoin trades processed in Canadian Dollars since the first data point in September 2011. The chart shown displays how Bitcoin’s volatility, since peaking at ~350% in late 2013, has fallen to its current level of 18.24% (a reduction of some ~95%). Determining the average historical volatility for a 30 day period by year, the trend becomes even more apparent.
Volatility is simply a measure of the degree of variation over time, where typically, an asset that is more volatile is considered more risky. Volatility can generally be categorized into two groups; Historical volatility (which is what the CBVIX references) and implied volatility. Simply put, historical volatility is a measure of past volatility by measuring previous market movements whereas implied volatility is a derived measure of volatility from trading derivatives, specifically options.
Volatility is typically presented as an annualized figure such that we can directly compare different asset classes which may trade over different periods. For example, the current CBVIX value is ~18% which means that in the next year, assuming that the current levels of volatility stay constant, we may expect the price of Bitcoin to fall within plus or minus ~18 % of the current value. So, given the last closing price of $554.92 and the HV(30) value of 18.24% if Bitcoin’s volatility maintains the current level we expect in the next year the price to fall in the range of $656.14 and $453.70.
Whilst elevated volatility is generally considered a positive for active traders, who can profit from the large price swings, when used as a currency stability is naturally preferred. Bitcoin’s history of volatility has led to services, which whilst they allow users to accept Bitcoin as a form of payment, they are immediately converted to fiat to remove the risk of dramatic movements in the value of Bitcoin. Alternative services, and so-called stable coins (such as the Bitshares BitUSD) have been created to peg the value of Bitcoin to other asset classes such that the user does not have to convert to fiat but instead retains their Bitcoin at the current rate, in the asset of their choosing, through the use of derivatives.
Comparing Bitcoin’s current historical volatility to other asset classes it is currently approaching that of Gold, the TSX stock market index and even the Canadian Dollar relative to the US Dollar.
Whilst historical volatility is a useful metric it tells us nothing about future volatility. Indeed, low volatility is often a precursor of a larger move. When prices are stable this indicates a relative equilibrium of supply and demand and once this equilibrium is broken for any reason there may be a sharp move in either direction. To predict future volatility we turn to implied volatility.
Implied volatility is a derived value for volatility that is calculated based on options prices, which means it is derived from actual trades being placed as to how volatility will behave in the future. As such implied volatility may be used as a forward looking measure.
To summarize the Nobel prize-winning Black-Scholes options pricing model:
The price of an option can be derived from seven factors. The only factor we don’t know is volatility i.e. the volatility in the future. However we do know the historical volatility so all things being equal we can come up with a ‘fair’ price for an option.
Rearranging this logic if we know the actual price that has been traded for an option we can determine the implied, that is the expected, volatility. However unlike stocks, there isn’t an established options market for Bitcoin and those that exist are thinly traded which makes this forward-looking analysis currently not feasible. It is likely only a matter of time before the options market in Bitcoin establishes itself and we are able to calculate implied volatility. With the unknown effects of the upcoming halving of rewards on the price, we would for example, expect implied volatility to be elevated leading up to that date.
CBVIX data is freely available via cbix.ca, the CBIX volatility API or via the Quandl data platform using ticker CBIX/CBVIX. As well as Bitcoin volatility the volatility of the TSX and Gold are also recorded for reference purposes.