Bitcoin is an extremely volatile asset, meaning it has a strong tendency to go up (or down) quickly over time.
People tend to think of volatility as downside risk, but the term also refers to growth. This high volatility is one thing that stops many investors from buying bitcoin. However, volatility is actually one its most attractive attributes.
“The volatility is the price you pay for it to be 10x outperforming the S&P Index for a decade and be outperforming Nasdaq and the S&P by a factor of eight in the last 12 months.”
Michael Saylor, CEO MicroStrategy
What Drives Prices?
To learn why bitcoin is volatile, we must look at what drives the price. As with any asset, the basic economic principal of supply and demand sets a free market price.
Bitcoin has a fixed total supply (21 Million bitcoin), and an algorithmically controlled coin issuance, which means that demand is essentially the sole driver of price.
This characteristic of demand only pricing is unique to bitcoin. Other assets like houses and gold have an elastic or semi-elastic supply.
When demand for residential houses soars, it drives the price up, but eventually more houses are build. Building more hoses expands the housing supply, and the supply / demand gap is filled which levels out price.
Another interesting aspect of price and volatility, is that demand for bitcoin is partially driven by its own price. When the price of bitcoin goes up, more people become interested and purchase bitcoin, which drives the price up even further.
Market Cycles
Bitcoin has a history strong price appreciation, which eventually attracts a storm of frenzied FOMO buyers that continue to drive up the price. This viral nature creates a pattern of boom, bubble, and bust cycles.
These cyclical patterns are not unique to bitcoin. Free markets produce cycles organically. They’re a healthy, necessary aspect of the free market. Recessions drive out bad debt in a market. It’s like a purging that must happen, in order to build a stronger foundation on top of.
Look At The Big Picture
When in doubt zoom out! If you look at Bitcoin price action through a narrow window (hourly, daily, weekly, monthly) it can be scary. On any given day, Bitcoin could be going up, or it could be going down.
However, if you zoom out and look at the bitcoin price over the course of multiple years, it’s easy to see that it reliably goes up. In the history of bitcoin, there has never been a 4 year period that has been unprofitable.
Want to learn more? Check out my article: Should I Buy Bitcoin? It has tons more information, and I share my favorite place to buy Bitcoin.