Anybody who has ever traded the bitcoin market is likely well aware of one thing—it is notoriously volatile. Events that would barely move other markets can have a dramatic, but typically short-lived effect on bitcoin.
Here, we examine some of the most recent cases of volatility, and posit the possible rationale behind the madness that is bitcoin trading.
Case in point
The most prominent overreaction in recent months was caused by comments from Chinese President Xi Jinping last month. During a speech made to the 18th collective study of the Political Bureau of the Central Committee, President Xi praised Bitcoin's underlying technology, blockchain, hailing it is an important breakthrough.
Almost immediately after President Xi's remarks were made public, bitcoin spiked from under $7,500, up to almost $10,000—rising by a third in less than a day—ending more than a month of decline. However, once the hysteria died down, the price of bitcoin again resumed its downtrend, falling back below $7,500, to its lowest value in over six months.
This isn't the first time a president's remarks have significantly influenced bitcoin's price action either. Back in July, US President Donald Trump posted a series of tweets slamming bitcoin, calling it "highly volatile and based on thin air," while remarking that unregulated crypto assets facilitate illegal activities.
That day the price of bitcoin fell from $12,000 to $11,200. But by the next day, the panic was over and the price rose back up towards $12,000.
Other events have similarly caused mass hysteria in the bitcoin market. In June, a flash crash on the Kraken cryptocurrency exchange saw bitcoin briefly fall to $100—potentially as a result of a single large compromised account. This resulted in one of bitcoin’s largest-ever single-day dumps.
And yet again, once people realized the damage was limited, the price bounced back.
Explaining bitcoin’s extreme volatility
Since many cryptocurrencies, bitcoin included, derive much of their value as speculative investment vehicles, it stands to reason that any event that can significantly affect investor sentiment could alter its price action.
But in the bitcoin market, this is taken to the extreme, largely spearheaded by factors described as Fear Of Missing Out (FOMO)—people jumping on positive price action—and Fear, Uncertainty and Doubt (FUD)—a term used for negative news.
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“With the unpredictability of future trends, the crypto market reacts highly emotionally to positive as well as negative news or events,” said Gregor Krambs, cofounder of Alternative.me, which builds the Crypto Fear & Greed Index tool used to track sentiment in the crypto market.
“The outcome of these mostly irrational decisions are driven by emotions of fear and greed, which get amplified by the vast amount of participants acting in the market,” he added.
Prominent trader known as CryptoVince argues that institutions make the most of this, exaggerating the price swings. He told Decrypt, “Retailers usually FOMO in upon good news causing a quick increase in price. Institutions countertrade the FOMO and sell/short bitcoin which will dramatically drop in the mid-term.”
“The exact opposite can also occur when bad news appears, which can explain bitcoin's price action in late October," he said.
As a result, significant good or bad news can cause a sudden rally or drop, as first responders emotionally react to the news, CryptoVince argued. This is then followed by algorithmic responses from higher volume traders, and lastly casual traders catching the back end of the price action.
As the initial hysteria dies down, the price then begins to stabilize, with a trend reversal often following shortly after.