Fidelity Research: Deep Dive into Bitcoin Volatility

Instead of analyzing the events and drivers of recent volatility, we explore volatility at a more fundamental level, exploring why Bitcoin is so volatile and how to look at it.

Why is Bitcoin so volatile

Almost every coin holder is familiar with Bitcoin’s price volatility, and of course because such volatility always makes the headlines. But why exactly is Bitcoin so volatile? Fundamentally, what is causing this phenomenon?

First, it is helpful to distinguish between short-term and long-term volatility. Short-term volatility factors may include factors such as news coverage (especially negative news), major changes in macroeconomic indicators or conditions, and the state of Bitcoin futures and leverage, all of which we have discussed and analyzed in past newsletters. These factors also cause short-term volatility in stocks and other assets, so it’s not hard to understand.

However, the question remains: why is Bitcoin still unstable in the long term? Why do we see Bitcoin’s price rise by thousands of percent over months and years, only to drop 50% or more? Part of this is due to the unique properties of Bitcoin, namely a fixed supply and issuance schedule.

Unlike other commodities, Bitcoin’s supply curve is fixed

Bitcoin is unique in that it is a commodity whose supply is completely inelastic to price changes. In other words, supply does not (and cannot) change with price. Bitcoin’s token issuance policy is pre-programmed. Therefore, all changes in Bitcoin demand are reflected by changes in the price. Even in the long run, changes in supply cannot dampen the effects of price movements.

An example of a different cargo or commodity can help illustrate this, such as oil. The world’s demand for crude oil has been growing almost all the time, with only a brief dip in recessions. Long-term prices, however, have not shown a similar trend of only rising and not falling. In fact, the inflation-adjusted price of WTI crude has actually fallen by nearly 9% over the past 15 years, while demand has risen by about 14% (at end-2021 prices, according to Bloomberg data).

Fidelity Research: Deep Dive into Bitcoin Volatility

Going back to economic principles, we know that when the demand for a commodity increases, the price increases in the short term. However, higher prices will incentivize suppliers to produce more. More supply will bring prices down. The U.S. witnessed this when oil prices were high enough to make the previously uneconomical fracking technology profitable, and then increased supply. In conclusion, if demand increases, prices may rise, and high prices stimulate increased supply, which drives prices down. The ability to change supply can act to stabilize prices.

For Bitcoin, no matter how the price changes, the supply does not change. Therefore, any change in demand, whether short-term or long-term, must be reflected by a change in price. This means that prices will be more volatile.

Bitcoin’s value and volatility are inextricably linked

This also illustrates a deeper point of Bitcoin and volatility, which Bitcoin evangelist Parker Lewis summed up succinctly: “Bitcoin is valuable because its supply is fixed, and its volatility is driven by Same reason.” In other words, one of the reasons Bitcoin is valuable is that it has scarcity, but that scarcity comes from its fixed supply, which in turn makes it more volatile, as we explained above That way. Therefore, Bitcoin’s volatility cannot be eliminated without eliminating Bitcoin’s fundamental value proposition.

Put volatility in the right frame

While volatility isn’t usually something investors want, it helps if it matters to core investment theory. For example, suppose an investor’s investment objective is to allocate a certain percentage of capital to an asset class that will preserve its value over the long term (say, at least 10 years).

Furthermore, suppose there are two distinct asset classes. The former has very low volatility but is not expected to maintain value in terms of purchasing power. The second has incredibly high volatility but is considered a store of value. The second asset class would be the right choice for investors as it is more likely to achieve their investment objective of preserving value over a defined time frame. While volatility is not desired, it is not part of the goal and will not matter in 10 years. What matters is whether the target is achieved at the end of the decade, not necessarily at any point throughout the decade.

These two asset classes show how the USD has actually performed against Bitcoin over the past 10 years. For example, the purchasing power of $10,000 10 years ago is now only $8,070 as measured by the Consumer Price Index, a depreciation of more than 19%.

Of course, Bitcoin was trading at just over $5 a decade ago, so any return calculation on Bitcoin captures some of Bitcoin’s most astonishing performances, even though it was a nascent or almost non-existent at the time. asset class. However, looking back over the past five years, we can still see that the U.S. dollar’s ​​store-of-value proposition remains poor compared to Bitcoin:

Fidelity Research: Deep Dive into Bitcoin Volatility

The U.S. dollar is not volatile, but it is also not a great store of value in terms of purchasing power, while Bitcoin is considered very volatile, but has been a better store of value over the past decade or even five years. The point is, something with low volatility is not necessarily a good long-term store of value, and something with high volatility doesn’t mean it can’t be a good long-term store of value.

Emerging asset classes are not immune to volatility

We know that with a market cap of around $700 billion today, Bitcoin has achieved the status of an emerging or small asset class in the eyes of many investors. We also know that Bitcoin initially had zero market cap and value. But what happened during this period? How did we get from point A to point B? How did Bitcoin become a larger, more established asset class?

On a macro level, the answer may seem simple: more and more people are adopting Bitcoin and buying it at higher and higher prices. But a deeper look at microeconomic processes reveals some key roles for volatility.

There is no doubt that investors are very familiar with the efficiency of the market at the macro level and are used to seeing the price of almost everything on the screen, and the value of their holdings or portfolios. What is often forgotten is that the “market” is not a monolithic machine good at discovering the value of securities and investments, but is made up of billions of individuals. The incorporation of new information and a “market” that reflects price information is a process, not a static or one-time evaluation.

The market is made up of individuals in action, and a large percentage of these individuals now see the value in Bitcoin and buy Bitcoin accordingly. But this group of people did not form this belief at the same time or in the same way. Everyone has to go through the process of understanding Bitcoin and its value proposition. Some may have bought and held at different times, while others may have traded before opting for a long-term allocation.

Therefore, the process of individuals adopting Bitcoin in different ways and time frames is bound to be volatile. Volatility is a by-product of price discovery, and in a free market, there is no other way to achieve price discovery.

Gold as an example of an emerging asset class

If this sounds too esoteric or all theoretical, a recent example of gold emerging as an asset class might help. Until 1971, gold was used as currency in various forms, or at least pegged to the dollar, so that gold was pegged to a certain amount of dollars.

In 1971, President Nixon abandoned all links between the U.S. dollar and gold, removed the peg or fixed exchange rate between gold and the U.S. dollar, and adopted a free-floating exchange rate.

This created a gold market, and the price of gold is now determined by the forces of free supply and demand. Investors are now faced with the question: How much is gold worth? Today, the total value of gold globally is estimated to be around $12 trillion, making it a large and mature asset class in the eyes of many investors.

As the chart below shows, gold has not entered this established asset class in a consistent, predictable or low-volatility fashion. Also, it will be interesting to see how Bitcoin broadly follows a similar pattern. However, please note that simple overlays or comparisons of charts should not be used as models or indicators of any kind. We’re just highlighting here a historical example of an emerging asset class that has gone through a very volatile period as it goes through its own price discovery process.

Fidelity Research: Deep Dive into Bitcoin Volatility

Historical and future volatility

As gold went through a major price discovery process in the 1970s, which led to a larger investor base, volatility naturally declined. We believe Bitcoin will go through the same process, in fact, the limited historical evidence we have so far seems to suggest that Bitcoin’s volatility is declining over the long term.

Fidelity Research: Deep Dive into Bitcoin Volatility

In conclusion, we believe that in times of high volatility, it is helpful for investors to revisit some of Bitcoin’s seemingly fundamental properties and why it is so volatile. Bitcoin’s volatility is also what makes it valuable, and while it can be disconcerting at times, this volatility suggests that Bitcoin is emerging as an asset class and thus may be achieving its ultimate investment goal of long-term preservation of value.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/fidelity-research-deep-dive-into-bitcoin-volatility/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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