Now that we have gone through Bitcoin’s fourth halving event, which was followed by Bitcoin’s recent and significant rally to a new all-time high, we can analyze and determine to some extent some of the patterns and factors that contribute to these price movements how the reduction in supply affects market behavior, investor sentiment and long-term price trends.
Perhaps such rallies can be attributed to some positive regulatory developments in various countries, providing a more favorable environment for cryptocurrency trading and usage. The anticipation of possible approval for spot Bitcoin Exchange-Traded Funds (ETFs) in the United States has generated excitement among investors, as such approval is likely to bring a greater degree of mainstream acceptance and liquidity to the market.
However, there are many concerns about regulatory scrutiny, market manipulation, and the volatility inherent in cryptocurrencies that could affect the approval process and subsequent performance of Bitcoin ETFs.
Bitcoin: A retail-driven market vulnerable to economic stress and regulatory uncertainty
Unlike stocks, which are backed by institutional investments and buffered against severe volatility, or gold, which is anchored in tangible value and historical stability, Bitcoin’s market is more fragmented, and largely driven by retail investors. This makes Bitcoin particularly susceptible to economic stress, as its liquidity is insufficient to manage large, panic-induced flows without causing significant price disruption.
Zachary Michaelson, Snr. Director Digital Assets & Emerging Technology Lead for digital transformation company Publicis Sapient says: “Bitcoin operates under a cloud of regulatory and legal uncertainty. Any global economic shift that suggests tighter crypto regulations, or legal actions such as criminal enforcement or bankruptcies of major players, can provoke sharp, excessive volatility.
“Traditional assets like gold and stocks, on the other hand, are regulated within well-established frameworks that typically protect them more from uncertainty and exposure to individual bad actors. Economic variables such as inflation or interest rate adjustments affect asset classes differently. Bitcoin’s reactions have been more volatile, heavily swayed by investor sentiment and speculative trading.”
Structural disruptions in market dynamics, which occur around major world events, lead to shifts in trading behavior and market perceptions, further influencing Bitcoin’s price fluctuations.
Bitcoin’s perceived role as a diversification tool during market stress affects its volatility as it attracts attention from fund managers and investors looking to reduce risks associated with conventional assets.
Behavioral factors, such as the nominal price illusion, also play an important role in the cryptocurrency market. This means that low-priced cryptocurrencies are often more volatile than their high-priced counterparts. Thus, the price level per se also plays a key role in its volatility, indicating the presence of irrational behavior in the crypto market.
The impact of global economic events on Bitcoin
Until 2021, Bitcoin and cryptocurrencies in general were considered uncorrelated with traditional assets such as stocks and bonds.
“Many research articles have been devoted to the role of Bitcoin as a hedge or a safe haven from a portfolio perspective. Given the absence of correlation, Bitcoin can be used valuable as a diversifier. In 2022, the consecutive interest rate hikes by many central banks and the fall of FTX led to a decline in both the financial markets and cryptocurrencies. Bitcoin’s sharp decline (-70%) was comparable to the decline of the NASDAQ index,” says finance professor Nathalie Janson, NEOMA Business School. .
Kate Leaman, chief market analyst at AvaTrade, adds: “Unlike traditional assets, Bitcoin reacts with a unique sensitivity to global economic events.
“For example, when traditional markets face uncertainty, investors may turn to gold as a ‘safe haven’, which usually stabilizes its price. However, Bitcoin, considered by some to be digital gold, often experiences sharp price movements under the same conditions due to its speculative nature and the varied sentiments of its global investor base.”
The relationship between gold and Bitcoin is also significant as gold is considered a store of value and a safe haven, showing a low correlation with traditional assets such as stocks and bonds. Bitcoin and gold have often been compared, with Bitcoin being dubbed “Gold 2.0”. The analogy comes from the limited supply in both cases and the fact that they are both expensive to produce/extract as they require energy.
The role of regulatory changes in Bitcoin’s volatility
“Regulatory changes significantly affect Bitcoin’s volatility,” says Nathalie. “For example, when China decided in April 2021 to ban any Bitcoin-related activities, including mining, it led to a huge drop in Bitcoin price from around US$64,000 to US$48,000.
“This decision has not only negatively affected the crypto business but also the crypto mining sector and came as a surprise. Conversely, the anticipation of the SEC decision to authorize a spot Bitcoin ETF had a positive impact on Bitcoin price. It started to rise again in October 2023 in the hope of approval and continued to rise until March 2024.”
James Sullivan, Group General Counsel and UK General Manager of Bitstamp, adds: “Regulators play an important role in investor perception of Bitcoin. Crypto is not regulated, but regulatory oversight of the sector and market participants positively affects Bitcoin’s price through mainstream acceptance and promote investor confidence.
“By providing a clear legal framework, regulation that aligns more closely with traditional finance can instill greater confidence in both retail and institutional investors. Regulatory certainty often catalyzes greater participation in the market, leading to increased demand and consequent upward pressure on prices.”
Without the institutional safeguards that traditional securities have, Bitcoin is particularly vulnerable to regulatory changes. Recent legislative changes have allowed the introduction of Bitcoin ETFs, leading some to believe that this would result in significant institutional investment. However, it appears that this expected institutional demand did not materialize, and the price rise following the launch of Bitcoin ETFs has since waned.
The effect of large containers on Bitcoin’s price stability
Whales exert a disproportionate influence on Bitcoin’s price due to the concentration of significant holdings among a few individuals. Their ability to execute large trades can cause significant price swings due to the market’s relatively low liquidity.
Whether buying or selling, these transactions can cause chain reactions across the market, either driving prices up with large purchases or causing sharp declines with significant selling.
Traders closely monitor whale exchange activity for signs of impending large-scale transactions.
This anticipation or reaction can increase volatility, as even rumors or perceptions of a whale’s potential market moves can lead to significant price swings.
Jonathon Hughes, Head of Emerging Tech at MDRx, adds: “Historically, Bitcoin whales have shown an ability to influence Bitcoin prices. Their network of wallets is constantly tracked, meaning that a move in either direction can increase participation cause.
“Whales are aware of this and influence the market to match their trading strategy, such as short selling, pump and dump, and stop-loss hunting. Very large whales are in line with the core principle of the technology and help to defend the market position of the asset.”
Technological developments and Bitcoin’s price stability
Developments such as the Lightning Network, which facilitate faster and cheaper transactions, aim to improve Bitcoin’s functionality for commerce. However, while this scalability may improve its general utility, it does not directly address the core volatility that undermines its utility outside of speculation.
Introducing smart contract capabilities to Bitcoin could theoretically expand its use cases beyond commerce, mirroring efforts seen on platforms like Ethereum.
However, increasing Bitcoin’s utility through these means will not necessarily suppress its price volatility and may even introduce new avenues for speculative behavior.
Zachary Michaelson says: “Advances in cryptographic security and wallet technologies can bolster investor confidence and can reduce the chances of certain types of panic-driven selling. Nevertheless, these measures mainly improve security rather than directly moderating the wild price fluctuations as certain very specific scenarios.”
The evolution of Bitcoin’s volatility
While there is a trickle of serious institutional capital in Bitcoin, broader institutional engagement remains lukewarm. The critical factor here is not just participation, but its nature – whether institutions invest for long-term holdings or short-term speculative gains.
Institutional involvement can either mitigate or exacerbate volatility, depending on the nature of the participation, and at the moment it seems to tend to exacerbate volatility, not stabilize the market.
Professor Samuel Ouzan says: “The degree of connectedness between cryptocurrencies changes over time and is higher during periods of market uncertainty.
“Increased connectedness leads to greater volatility consequences, implying that during turbulent times the interaction between cryptocurrencies becomes more pronounced, affecting Bitcoin’s volatility more significantly. Bitcoin’s role as a leader or follower in the cryptocurrency market also affects its volatility.
“The evolving dynamics of Bitcoin mining also play a crucial role. As block rewards decrease and operating costs escalate, miners may be forced to sell their holdings to cover expenses, especially around halving events.
“This necessity can introduce additional volatility, affecting supply dynamics on exchanges. The declining incentive to mine could lead to shifts in the miner population, further affecting Bitcoin’s price stability.”
If global interest rates remain high and eventually result in a broad deleveraging event, this evaporation of speculative capital and demand for liquidity could be disastrous for Bitcoin’s price and volatility.
Ultimately, Bitcoin is unlikely to become a “mature asset” with moderate volatility and an investment-grade risk profile in the near future. Its speculative nature, driven by investor sentiment and market dynamics, suggests that volatility will remain a core feature of Bitcoin for the foreseeable future.
Kapil Dhiman, co-founder and CEO, Quranium says: “Overall, while Bitcoin is likely to remain volatile in the short term, these combined efforts to improve regulatory clarity, technological security and institutional engagement could lead to a more stabilized market in the long run.
“However, the exact trajectory of Bitcoin’s volatility remains uncertain, making continuous monitoring and adjustment imperative for stakeholders in the cryptocurrency.”
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Disclaimer for Uncirculars, with a Touch of Personality:
While we love diving into the exciting world of crypto here at Uncirculars, remember that this post, and all our content, is purely for your information and exploration. Think of it as your crypto compass, pointing you in the right direction to do your own research and make informed decisions.
No legal, tax, investment, or financial advice should be inferred from these pixels. We’re not fortune tellers or stockbrokers, just passionate crypto enthusiasts sharing our knowledge.
And just like that rollercoaster ride in your favorite DeFi protocol, past performance isn’t a guarantee of future thrills. The value of crypto assets can be as unpredictable as a moon landing, so buckle up and do your due diligence before taking the plunge.
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