One of the most infamous characteristics of bitcoin (and most other cryptocurrencies) is its volatility. Unlike the traditional market where the CBOE Volatility Index measures volatility, there’s yet to be a generally accepted index to measure bitcoin’s volatility. Still, bitcoin’s volatility is very apparent in its ability to jump or drop in value by up to 10 times versus the U.S. dollar within a very short period. Since there are not many assets that can increase or drop in value by such a high multiple within the short period that bitcoin does, you’re most certainly asking why. What are the factors affecting the price of bitcoin? We’ll look into these below.
The first thing to note is that the price of bitcoin is fundamentally driven by its demand and supply spectrum. It should be noted, though, that bitcoin has a fixed supply of 21 million. That is the maximum number if bitcoin that will ever exist. This means that the demand side of things is what influences the price of bitcoin for the most part. But then, it’s the factors that drive the demand for bitcoin that actually drive its price. Here are four factors that greatly affect the price of bitcoin.
Bitcoin was conceived to be peer-to-peer money that doesn’t work like fiat currencies work. It launched without the involvement of a government to regulate it. As the cryptocurrency grew in popularity, with reports suggesting that it’s being used to pay for or fund illicit activities, the government had to step in with some form of regulations. Governmental interference has historically caused panic in the cryptocurrency market. That’s because the involvement of the government trumps what bitcoin and other cryptocurrencies stand for. For one, there’s the fear that holders of cryptocurrencies could lose their holdings to a government ban. This idea makes crypto owners want to sell quickly so as not to lose their wealth. This drives down the price of bitcoin in the process. This has played out during a couple of governmental interferences. On Dec. 5, 2013, the Chinese government banned its banks from using bitcoin over fears that it could be used to fund terrorism1. Following the announcement, bitcoin dropped from nearly $1,100 to about $730 by Dec. 8, before reaching a low of about $560 on Dec. 19, 2013. Such reactions have been characteristic of all (anticipated) governmental interference.
There’s a reason banks are heavily guarded with armed men. People’s wealth that has been entrusted unto banks has to be kept safe. Anything that threatens the safety of people’s wealth will definitely keep them away. The same applies to bitcoin and in its case, the fear of security is heightened because the money is kept on the internet, which is not a conventional bank. In addition to the fact that the internet is not a conventional bank, the growing cybersecurity threat attached to the internet is a bigger worry. Various governmental agencies around the world, particularly in the U.S., have been pointing out that cybersecurity is now a greater national and international threat than terrorism2.
In reality, we’ve seen hacks of bitcoin exchanges lead to the decline of the price of bitcoin. The most notorious hack was that of Mt. Gox in 2014. The now-defunct exchange, which was the largest at the time, was involved in a hack that led to the loss of 750,000 bitcoins belonging to its customers. At the time, that was worth over $470 million. Between Feb. and March, the duration of the Mt. Gox mishap, bitcoin dropped by approximately 36 percent3. Again, this is the similar theme for every hack that happens in the cryptocurrency space.
Updates on use cases
Because bitcoin is still in its nascent stage, many are still unsure of how bitcoin can be used in the future — weather as an internationally accepted legal tender, a safe haven asset like gold, an instrument to help improve financial inclusion and so on. Change on how people see bitcoin in these lights typically affect its demand. For instance, if there are reports that a country is about to allow the use of bitcoin as a legal tender, crypto enthusiasts would be quick to buy more of the cryptocurrency so as to benefit from the potential increase in value that would come with such development. In addition, if there’s a reputable report that bitcoin might not be as useful in the future as it’s being purported to be, it’s very likely to drive down the demand for bitcoin and hence, it’s price.