Bitcoin's Volatile Nature: Why You Should Still Invest

Bitcoin is a highly volatile cryptocurrency, with a price that can fluctuate by thousands of dollars in a single day. Despite this volatility, some financial planners see value in purchasing bitcoin as a speculative asset.

Bitcoin's volatility is due to its design: it has a limited supply, no central bank, and is still a nascent asset class. Its value is heavily influenced by supply and demand, investor and user sentiments, government regulations, and media hype.

While bitcoin's frequent price fluctuations undermine its reliability as a store of value or a hedge against inflation in the short term, it can be used as a safe haven during stable periods.

Financial planners advise that bitcoin should not be the cornerstone of your retirement plan. Instead, it can be considered a small part of your portfolio if you have a strong interest in crypto and understand the risks involved.

Bitcoin's limited supply and lack of central bank

Bitcoin's limited supply is a fundamental aspect that sets it apart from traditional currencies. The cryptocurrency has a capped supply of 21 million coins, which is written into its protocol code. This deliberate scarcity prevents inflation and ensures Bitcoin remains a finite resource. The limited supply of Bitcoin is closely tied to its decentralised nature, as it operates on a peer-to-peer network, making it resistant to censorship and government interference.

Bitcoin's decentralised system also means it is not controlled by central banks or governments, and its supply cannot be manipulated. This is in contrast to fiat currencies, which can be printed at will by central banks. The absence of a central authority means that no single intermediary, such as a central bank, is involved in Bitcoin transactions. Instead, transactions are verified by a network of nodes that check the accuracy of the latest transaction against their register of total transactions, called the blockchain.

The scarcity of Bitcoin has led some to view it as a hedge against inflation and a store of value, akin to precious metals like gold. The limited supply also suggests that as demand increases, its price may appreciate over time. The law of supply and demand dictates that with a finite supply, increased demand could drive up the value of each Bitcoin.

Bitcoin's value as a safe haven

Bitcoin's volatility is due to its design. It has a limited supply, and there is no central bank to control that supply. As a result, its value is derived from its decentralised network, and no central authority can intervene in the market to stabilise prices.

Some experts argue that Bitcoin's high volatility undermines its reliability as a store of value or a hedge against inflation, especially in the short term. They believe that its value seems to largely hinge on speculation and market sentiment, rather than intrinsic value, making it a risky asset compared to stocks or bonds.

However, others highlight that Bitcoin's volatility can be advantageous in certain situations. With high volatility, Bitcoin can be used as a safe haven. In other words, during speculative periods, Bitcoin's volatility is more unstable. On the other hand, in stable periods, S&P 500 returns, VIX returns, and sentiment influence Bitcoin volatility.

Additionally, Bitcoin's long-term price trend is positive, and it has a "deflationary design" due to its fixed supply. This suggests that it can be considered a store of value, despite its short-term volatility.

Overall, Bitcoin's value as a safe haven is a matter of debate, and it depends on various factors, including market conditions and investor sentiment.

Bitcoin's volatility in the price discovery phase

Bitcoin is still in its infancy, and its price is in the discovery phase. This means that its price will continue to change as investors, users, and governments work through the initial growing pains and concerns until prices stabilize—if a stable point can be reached.

Bitcoin's price depends heavily on supply and demand. As an asset, it has been quickly adopted by investors and traders, and speculation about price movements plays a critical role in Bitcoin's value at any given moment.

Media outlets, influencers, opinionated industry moguls, and well-known cryptocurrency fans create investor concerns, leading to price fluctuations. Bitcoin's market value is affected by how many coins are in circulation and how much people are willing to pay.

Bitcoin's volatility is also driven by large investors, known as "whales". It is unclear how these whales would liquidate their significant positions into fiat currency without affecting Bitcoin's market price. If they were to begin selling their Bitcoin holdings suddenly, prices would plummet as other investors panicked and followed suit.

Fear and greed are two primary drivers behind Bitcoin's volatility and prices. Because of its well-known volatility, investors fear that they will miss out on big upswings or fall victim to large downswings. This causes many of them to panic sell or buy, influencing demand and, therefore, prices.

Bitcoin's volatility is also driven by its varying utility as a store of value and method of value transfer. Many investors believe that Bitcoin will retain its value and continue growing, using it as a hedge against inflation and an alternative to traditional stores of value like gold or other metals.

The price discovery phase of Bitcoin is influenced by a variety of factors, including market sentiment, regulatory changes, technological developments, and the wider economy.

Bitcoin's high risk, high reward nature

Bitcoin is a high-risk, high-reward investment. Its price volatility is almost 10 times higher than that of major exchange rates, making it difficult to use as a medium of exchange or store of value. The cryptocurrency's value is heavily influenced by supply and demand, with its limited supply of 21 million coins contributing to its volatile nature.

Bitcoin's volatility is also driven by investor actions and market sentiment. Investors with large holdings can significantly impact its market price, and fear of missing out on price movements often leads to panic buying or selling. Negative news and regulatory changes can also trigger significant price drops, as seen with China's crackdown on cryptocurrency transactions in 2021.

Despite the risks, some financial planners see the potential for high returns in Bitcoin. It is often viewed as a speculative asset, similar to gold, due to its limited supply. However, unlike gold, Bitcoin lacks a long history as a reliable store of value and has more speculative value.

Bitcoin's high-risk, high-reward nature makes it a risky bet for retirement savings. Financial planners generally recommend a well-diversified portfolio of stocks and bonds for steadier growth. Allocating a small portion (around 1-2%) of your portfolio to Bitcoin can be considered if you understand the risks and have a strong interest in cryptocurrencies.

Overall, Bitcoin's volatile nature makes it a speculative investment with the potential for high returns but also significant risks. It is crucial to understand these risks and ensure any investment aligns with your risk tolerance and financial goals.

Bitcoin's role as a store of value

Bitcoin's volatility is well-documented, and it has suffered significant drops in value over the years. In 2014, it lost 58% of its value, and in 2018, it dropped by 73%. From its peak in November 2021 to its bottom in November 2022, Bitcoin lost over 75% of its value. This volatility is almost 10 times higher than the volatility of major exchange rates, such as the US dollar against the euro and the yen.

Despite this, Bitcoin has some characteristics that could make it a potential store of value. Here are some arguments for and against Bitcoin as a store of value:

The store-of-value argument for Bitcoin

• Durability: As a digital asset, Bitcoin is not subject to physical wear and tear or degradation. It will exist as long as the decentralised network supporting it continues to operate.
• Portability: Unlike gold, which can be expensive to transport and store, bitcoins are easily portable. They are stored digitally and can be sent globally very quickly.
• Fungibility and Divisibility: Every bitcoin is interchangeable, and bitcoins are highly divisible, down to 1/100,000,000th of a unit (a satoshi).
• Scarcity: The supply of Bitcoin is capped at 21 million coins, making it a scarce asset.
• Verifiability and Censorship Resistance: Transactions are recorded on a public, transparent blockchain, making them easily verifiable. Bitcoin's decentralised nature also makes it difficult for any single entity to control or censor transactions.
• Liquidity and Utility: Bitcoin's liquidity and utility have improved exponentially in recent years, making it more accessible to users. More countries and businesses are accepting Bitcoin as legal tender and a form of payment, and Bitcoin exchange-traded products have emerged.

The store-of-value argument against Bitcoin

• Volatility: Bitcoin's high volatility means that it is difficult to use as a medium of exchange. For example, the daily volatility is regularly about 10%, and on some days, it reaches values above 30%. This makes it challenging to use Bitcoin for transactions without incurring significant exchange rate risks.
• Limited history: Bitcoin was created in 2009 and has a much shorter history compared to traditional stores of value like gold, which has been used for thousands of years.
• No intrinsic value: Bitcoin has no intrinsic value and cannot be valued using traditional methods such as discounted cash flows. This makes its movements more susceptible to sentiment and narrative.
• Lack of regulation: Bitcoin is not backed by any government or central authority, and its regulatory environment is heterogeneous across countries. This lack of regulation contributes to its volatility and makes it difficult to control and predict its value.

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