Playing Ball With Bitcoin’s Volatility
Tom Seaver’s MLB Stats May Be Your Answer
Tom Seaver spent two decades as an MLB pitcher, picking up three Cy Young Awards and an induction into the Baseball Hall of Fame. Among other things, the twelve-time All-Star is known for consistently impressive stats over his long career. On sustaining these numbers, Seaver said:
“My theory is to strive for consistency, not to worry about the numbers. If you dwell on statistics you get shortsighted, if you aim for consistency, the numbers will be there at the end.” — Tom Seaver
Seaver’s advice might just be worth considering for those of us waist deep in the world of crypto investing. While difficult to do, dwelling too much on short-term price movements can distract us from a steady focus on the long-term potential of this space.
But with so much erratic price behavior how are we supposed to keep our eye on the ball?
The Reality of Volatility
Let’s start with an unavoidable fact:
Cryptocurrencies, including bitcoin, are volatile. Really volatile — at least for now.
In 2017, bitcoin was up over 1,300% but also experienced five corrections of 30% or more. While price movements this year haven’t been as stomach-churning, crypto markets remain unpredictable. As CoinDesk recently reported, bitcoin had an inter-day trading range of greater than $1,000 more than 40 times in the first four months of 2018 alone.
So, what’s causing the wild price swings?
As is the case with most investing, there’s not a clear or definitive answer to why prices move in a certain way. What there is, however, are a number of factors we know contribute in some degree to bitcoin’s volatility.
The most important of these factors is that crypto is such a new asset class. With much untested and a lack of clarity around the rules, it makes intuitive sense that bitcoin’s price would be volatile. Compounding bitcoin’s “newness” is that unlike investing in a business, with bitcoin there is no balance sheet to analyze, revenues to measure, or CEO to scrutinize. The result is that determining the fundamental value of bitcoin can be more subjective than with other investing.
But we are learning more and more about the price activity of bitcoin and other cryptocurrencies, and while no one knows exactly what causes each big price move, here are three factors that have been contributing:
1. Futures Activity
Bitcoin futures started trading a week before its price reached an all-time high on December 17, 2017, and many have linked the price volatility that followed with the launching of these futures.
There was a lot of excitement about bitcoin futures leading up to the December launch, which contributed the price appreciation, but once they were launched some speculate that certain large investors decided that purchasing futures was better than holding the underlying bitcoin, causing — or at least contributing to — the early 2018 sell-off.
Because bitcoin futures are only a derivative of the underlying asset, more futures activity doesn’t directly correlate to more people purchasing bitcoin, which is why it’s hard to know the exact impact of futures trading on the bitcoin price.
It’s also important to remember that there is no agreement on the impact of futures on the volatility of an asset.
Some believe the use of derivatives (i.e., leverage) can accelerate losses in a downturn, while others believe futures activity lowers volatility because it increases overall liquidity in the spot market for the asset. Bitcoin’s volatility has in fact been lower in the last few months, a sign that the latter might be true for bitcoin futures.
2. Exchange Security
Remember Mt Gox? Yea, well so do most other cryptocurrency investors. This means that any time one of the many crypto exchanges is hacked or has a public security breach, people fear the worst and often run for the exits, or at least trim back their crypto holdings. This really isn’t solely about exchanges, as any bad press about a crypto hack or theft–regardless of where and how it occurred–can make investors want to sell.
Exchange security is improving which will hopefully give investors more confidence in the safety of their crypto holdings going forward.
3. The Big Guys
While bitcoin’s market cap (~$110 Billion) has grown at a rapid rate, it’s still a very small market compared to other markets (e.g., there’s north of $7 Trillion in the world’s gold supply).
What this means is that hedge funds and other big investors can move the price with large buy and sell orders much more easily than in other markets. There is nothing illegal or unethical about purchasing or selling large amounts of bitcoin, but it’s a different story if there are participants involved in manipulative activities such as collusion or creating fake orders to move markets.
Fortunately, as with illegal trading practices in other markets, the regulators take this very seriously. Currently, the US Justice Department is looking into possible criminal activity around trading bitcoin, and it’s important that bad behavior is identified and punished if these markets are to develop.
It’s also important to note that crypto investors to date have been primarily individuals, which has also contributed to volatility. As more institutional investors put their money to work in the space, most people believe there will be less volatility given the long-term investment horizons for these large players.
Batter Up
There many factors that contribute to the rise and fall of bitcoin’s price. Things like geopolitical events, government actions to regulate or ban cryptocurrencies, and of course negative press reports around anything crypto-related.
While it’s important to not let short-term volatility distract, it’s equally important to try and understand where these price movements are rooted. Volatility in itself is not a bad thing and certainly can create opportunities for savvy investors.
At the end of the day, investing in this industry will continue to require diligent research, data analysis and maybe, above all else, patience.
We are, after all, still in the early innings.
