What leads to Bitcoin’s Volatile Value?
Tags: Crypto, Cryptocurrency, Volatility, Bitcoin, Investors

Various factors lead to fluctuation in the value of Bitcoin. This fluctuation can be known as the volatility of Bitcoin. Volatility is measured in terms of volatility index. Fluctuation in Bitcoin does not have a generally accepted index since cryptocurrency as an asset class is still in its nascent stages, but we do know that Bitcoin is capable of volatility in the form of 10x changes in price versus the U.S. dollar, in a relatively short period of time.

Some of the factors affecting Bitcoin’s Volatility are listed below:-

Bad image in the media hampers the adoption rate:

Lately, there have been a lot of statements made by news events and the governments that Bitcoin is yet to be regulated. There occurred a number of episodes that created a fear of cryptocurrency in minds of both the existing investors as well as future investors. Early adopters of bitcoin includes various mal actors, producing headline news stories that produced fear in investors. Bitcoin news that made headlines includes- bankruptcy of Mt. Gox (2014). Tha more recent headline maker comprises of the South Korean exchange Yapian Youbit; and others like the high-profile use of Bitcoin in drug transactions via Silk Road that ended with the FBI shutdown of the marketplace in October 2013. All these incidents made the public panic and lead to rapid decrease in value of Bitcoin v/s fiat currencies. However, these events showed to the Bitcoin-friendly investors that the cryptocurrency market was getting to its stage of maturity. Bitcoin’s perceived value fluctuates:

Another reason behind the fluctuation of Bitcoin v/s fiat currencies is the perceived store of value versus the fiat currency. Bitcoin consists of properties that bring it in comparison to gold in investor’s view. It is governed by a design decision by the developers of the core technology to limit its production to a fixed amount, 21 million BTC. As economies built with fiat currencies show signs of strength or weakness, investors may allocate more or less of their assets into Bitcoin. Bitcoin’s store of value and method of value- perceptions:

Volatility of Bitcoin also occurs because of varying perceptions of the intrinsic value of the crypto currency as a store of value and method of value transfer. A store of value can be defined as the function which depicts that an asset can be useful in the future with some predictability. This function can be saved and exchanged for some good or service in the future whereas, a method of value transfer can be defined as the object that is used to transmit property in the form of assets from one party to another. At present the fluctuation of Bitcoin makes it an unclear store of value, but it allows almost a frictionless value transfer. Since, these two parameters of the current price of bitcoin vary against the dollar and other fiat currencies, we can observe that its value can swing based on news events much, as we observe with fiat currencies. Large holders of the currency get little option value:

With current holdings above around $10M for Bitcoin investors, it is not clear how they would liquidate a position that large into a fiat position without severely moving the market. Since Bitcoin’s volume resembles a small cap stock, the currency has not hit the mass market adoption rates that would be necessary to provide option value to large holders of the currency. Investors react to the news about security breaches:

When the Bitcoin community exposes security vulnerabilities in an effort to produce massive open source responses in the form of security fixes, that time bitcoin can also become volatile. This approach to security can lead to great outcomes. To produce robust solutions, Bitcoin developers must reveal the security concerns to the public.In April 2014, the OpenSSL vulnerabilities attacked by the Heart bleed bug and reported by Google security’s Neel Mehta drove Bitcoin prices down by 10% in a month.

Bitcoin and open source software development are built upon the same fundamental premise that a copy of the source code is free for users to examine and modify at will. This concept makes it the responsibility of the community to voice concerns about the software design, and when the community does so, the value of Bitcoin reflects the level of confidence in the protocol design as a whole. It is only natural then that the value would fluctuate with news events about security breaches. Bitcoin’s Tax Treatment:

Recent announcements by the IRS stating that the currency is actually an asset for tax purposes had mixed effects on volatility. On the upside, any statement recognizing the currency has a positive effect on the market valuation of the currency. Whereas, on the downside, the decision by the IRS to call it property had two negative effects.

The first was the added complexity for users who want to pay with it. Under the new tax law, users would have to record the market value of the currency at the time of every transaction, no matter how small. Clearly, this factor again leads to slow as it seems to be too much trouble for what it is worth for many users.

Secondly, the decision to call the currency a form of property for tax purposes may be a signal to some market participants that the IRS is preparing to enforce stronger regulations later. Very strong regulation of the currency could cause the adoption rate of the currency to slow to the point where it is not able to achieve the mass adoption that is critical for its overall utility in society.