On Volatility in Bitcoin, circa 2024/2025
The Bitcoin price is highly volatile, this much we all know. I’m sure you’re feeling it right now as we experience the first significant pullback of this early 2024–2025 bull market. Every bull market has these — I’ve been a bitcoiner since 2012 and I’ve seen my fair share of 20% corrections. As always, past results are no guarantee of future returns — but we can use data to help inform the decisions we make in preparing for the future. I am fairly confident that forward momentum will return again, as it has in every bull market before this one.
That said, I do want to give you a few things to think about at this juncture. I personally have a three part test to know whether or not it’s time to jettison from Bitcoin. You should always have a contingency plan with everything you do. The ability to execute is in equal parts made up of both preparation and chance — so don’t negate the preparation part. In addition to my test, I also have a few things related to why we see so much price volatility that I want to say. These reasons are of course not taking into account any macroeconomic reasons for short time scale price movements, for which I have seen several plausible explanations on the timing of this dip, and predictions for when we may expect the up trend to continue (January to February 2025 looks like consensus among macro folks — I am but a humble lay person). This article is not about the macroeconomic reasons for why trends in the Bitcoin price emerge. This article is about the structural and deeper reasons for why such volatility exists in the first place.
But first, my three part test for whether my Bitcoin thesis is still sound is as follows: a) has the 200 week moving average been above the current price for more than 30 days? b) has hashrate declined in the last 6, 12, and 24 months? c) have the consensus rules changed on the bitcoin network to eliminate either the difficulty adjustment or the 21 million coin cap? If all three are true, it’s definitely time to call it quits, Bitcoin has failed. If the consensus rules have changed, that requires serious evaluation, but doesn’t necessarily mean Bitcoin is dead. But price? Price isolated on its own is a terrible way to determine if Bitcoin as a project is done for.
So, given a price drop from $108k to $93k per coin as of time of writing doesn’t qualify for any of the three things in my test above, you can probably relax. Price movements are generally temporary noise. If anything, in the 24 months after a halving, they’ve traditionally been great times to buy. So as long as my test remains unmet, I acquire more Bitcoin on every dip.
However, you may still feel anxiety given how much your net worth may fluctuate. There’s always that possibility that this dip is the one that will last for several years and your purchasing power has diminished for a time. These are reasonable fears for the average person! What has helped me on this journey is understanding two fundamental things: one, that this volatility is normal as part of adoption and two, that it is a signal that you are still early and still have an information advantage over the major participants in capital markets about Bitcoin. This helps me cut through any anxiety I have about major negative price movements.
Why is Bitcoin Volatile?
There are several reasons for the sharp price volatility we see in Bitcoin. 1) Because its market cap is small and its liquidity/liquid supply can vary enormously. 2) There is an information gap in the market and many participants are still figuring out what exactly it is. For many, it’s a way to make additional dollars by correctly betting on the direction price moves will go. 3) the people who use Bitcoin as a trading vehicle to make dollars use leverage that frequently blows up when they are wrong. 4) There are few Bitcoin denominated liabilities (yet) which means there isn’t a strong economic incentive to hold it for medium term use. Therefore, the main use case for holding Bitcoin in the minds of many participants is either ideological or speculative (for now).
Small Market Cap, Liquidity, and Leverage
Okay, you’re probably thinking to yourself “$1–2 trillion in market cap is not small!” and in many cases you’d be correct. It’s a matter of total addressable market though. Microsoft is an enormous company at $3.25 trillion and they have to continually search for ways to aim for further growth. $3.25 trillion isn’t their terminal state of being, but it’s much close to that than it is to the beginning of their journey.
Bitcoin’s total addressable market is all money and all store of value. We could conceivably find ourselves in a future where all physical goods, all services, are priced according to their utility and capacity to improve productivity — and nothing else. Bitcoin could capture all store of value in addition to the use case of being the final layer of all human trade in the medium of exchange space. What the heck is the total value of that? We can only speculate — my hunch is about $700-800 trillion in 2019 USD¹ . Bitcoin’s market cap of $1–2 trillion is a drop in the bucket still. Assets at the early stages of their valuation tend to exhibit greater volatility. This ties into the next point:
Liquidity. Basically, if you create a large sell order (or buy order!) can you fill the order all at once at the current market price, instantly? I think one of the best illustrations of liquidity as a concept is looking at the live price book for garbage stock options.
Look at the spread of a call option on a lightly traded stock and you’ll see a discrepancy most likely. This is because there are few buyers or sellers and no one wants to either jump up or down to the mid market price. Here’s a concrete example.
Let’s say Stock ABCD has a lightly traded options market. You open the order book for a call option that expires in three days and the bid/ask looks something like this: $1.90 buy / $2.30 sell with a mid price of $2.10. Setting an order at $2.10 is very unlikely to execute unless there’s some price movement in the underlying ABCD stock. There are no buyers or sellers at that price. If you want to sell your call option and close the position, you need to set an order closer to $1.90, which is bellow the open order book of $2.30 or the mid of $2.10. Same maths in the other direction. This is what an illiquid market looks like.
With large market participants, they have to contend with this sort of thing at a massive scale. Basically, if they want to ensure they don’t blow out the market, they have to structure their orders according to how liquid the order book is. If you’re selling a lot of something, you likely are going to do it across multiple orders in batches so that you don’t blow out the order book. Big players value stable prices so that they can enter and exit positions in ways that make their models work. They often work to ensure an orderly market exists with price stability.
However, there are time where market participants just have to unload their positions; or similarly, they absolutely must acquire something — and they have to do it fast. Usually this happens as a result of being naked on an options play while using leverage where they are at serious risk of being assigned — ie if they took out a contract to sell 100 shares they don’t own, but the contract is looking likely to be assigned, they need to acquire those 100 shares at basically any cost.
In the reverse, someone who is bullish and uses their assets as collateral to further go long on that asset (ie they put 10 BTC up as collateral to borrow $1 million to buy more Bitcoin) will get a margin call (in USD) if the asset price dips below a certain threshold where the lender can no longer get their principal back by selling the collateral. Therefore, the levered buyer has to sell something (usually the asset they went long on) in order to satisfy the terms of their margin loan. That person is a seller at basically any price.
Coming back to Bitcoin, it has a highly liquid market most of the time. There are times though where a market participant has to either buy or sell at any price because they screwed up. In Bitcoin’s earliest days, large spot orders could blow out the order book. Today, the market is more mature and large market participants who buy or sell spot tend to structure their orders. Leveraged players however, are buyers or sellers at any price. There are times when panic sets in, when margin calls happen, all at once and the orderly nature of the order book collapses. This is where the huge price movements happen. The cure for disorder in the spot price is liquidity — ie there are tons of buyers and sellers at the current price.
Using the fiat foreign currency markets as an example, these are deeply liquid markets. There are constant buyers and sellers and the prices tend to only move in small percentages. It’s not that foreign currencies have some sort of magical quality. It’s just that there are a lot of entities that need to change between them. Mostly because they earn income in one currency and have liabilities in another. This takes us to the other points:
Use Cases, Beliefs, Prices, and Adoption
A great many participants in the Bitcoin market are entities looking to make more dollars on directional volatility trades. Many don’t even know how to actually use Bitcoin peer to peer, they trade contracts around the price of Bitcoin or use proxies such as the ETFs which buy and hold spot Bitcoin on their behalf as shares. These are useful participants in the market from the standpoint that they provide liquidity, but they are also a great source of volatility in that they are playing fiat games to win fiat prizes with Bitcoin as their chosen game piece.
This is only my belief, but I think we are continuing to see these giant, volatile price moves that Bitcoin has always been known for, because we don’t yet have many market participants who have liabilities in Bitcoin. Once you have market participants who need Bitcoin because they owe Bitcoin, you will start to see the Bitcoin to USD price market behave more like the USD to EUR market. That market is somewhat stable because there are essentially as many buyers and sellers because market participants have liabilities in both. The Bitcoin market is heavily skewed toward participants who exclusively have liabilities in USD, therefore there will be many times where they desire USD at any price (in BTC terms).
The other piece of the puzzle beyond contract liabilities in BTC is goods and services being priced in BTC. This is a bit of a circular phenomenon that will reinforce itself as adoption and BTC price increases: a larger market cap leads to more adoption, more adoption leads to more liquidity, more liquidity leads to more stable prices, that stability means people feel comfortable having prices and liabilities expressed in BTC. As this cycles keeps growing, the price volatility in USD terms will diminish (all else being equal and assuming the US Dollar doesn’t hyperinflate lol). This doesn’t take into account whether BTC becomes the unit of account for settling international trade. If that happens, you will see demand for actual, “physical” bitcoins go way up as states begin to outbid Wall Street in the US for custody of actual bitcoins.
Basically, you’re still seeing huge volatility because USD is still the ultimate safe haven when your liabilities are priced in it. Think of your own personal life. If you had a $1,000 bill that was due at the end of the month, but your only way to pay it off was to sell some stocks for dollars, you’d do that, right? Or, if you go on holiday to another country, you need to pay for things in the foreign currency, right? The only way to do that is to sell your native fiat for the foreign one (and that still happens when you swipe your credit card, it just happens in the background without your knowledge). That’s all.
Conclusion
If you believe in Bitcoin, if you think that it will be the unit of account for all human store of value eventually (as I do), this volatility is a great arbitrage opportunity in a sense. My thesis on Bitcoin would only change given the test I mentioned in the opening paragraphs of this piece. Any time the price goes down while that test hasn’t been met, that’s an opportunity, not a reason for panic. Every dip is an opportunity to convert your current depreciating capital into the currency in which your future liabilities will be denominated before everyone else realises that change is coming.
The volatility in price is proof that market participants still don’t understand what Bitcoin is. These price movements are mere noise on a long time scale as the clear trend has been adoption and market cap growth. That’s your information asymmetry advantage. It’s an opportunity. Don’t waste it.
[1] 2019 US Dollars is my preferred measure of value for the dollar if you haven’t caught on by now. Pre-September 2019 bond market dysfunction is essentially the last time the USD could claim to have any semblance to its former self. We’re in the post 2019 dollar world now.
