The Bitcoin Volatility Index is a charting tool that helps investors observe and predict the future price movement of Bitcoin. The graph below indicates BTC’s volatility compared to a 24hr timeframe (blue line) and to a 7-day timeframe (orange line).
Is Bitcoin a volatile investment?
Yes, Bitcoin is one of the most volatile investment options currently available. When compared with the stock market or precious metals, the difference is enormous.
For example, a sudden 10% drop in a popular stock option’s value, would be a catastrophic event that is almost never seen in such markets.
However, with Bitcoin, this is a normal day in the market.
How does a Volatility index work?
The Bitcoin Volatility Index is a tool that measures the fluctuation of the coin’s value, compared to the average value of a given timeframe.
More specifically, volatility calculates past price-action and uses this information to predict (in %) the potential of a sudden price change. A higher the % indicates a higher investment risk.
Why is Bitcoin so volatile?
When an asset is relatively new to the market and still has a small market cap, it will naturally be more volatile.
To give an example, let’s take a look at gold. The precious metal has been used as a store of value since barter times and currently has a market cap of $7,2 Trillion dollars.
Now, try to compare this to Bitcoin. The digital asset has a mere $170 billion dollar market cap and was only recently introduced to the world (2009).
It is only natural that Bitcoin, as well as other cryptocurrencies, will be a lot more volatile than gold.
As demand for Bitcoin grows, so will the coin’s market cap. This is because Bitcoin only has a limited supply of coins. With an increase in demand, there will be a growth in the price, and thus in the total market cap.
The good thing is – with a higher market cap, large-scale buy/sell orders will not affect the market as much.
In other words, the higher the price of Bitcoin, the lower its volatility.
How to calculate Bitcoin’s Volatility?
The percentage of volatility is measured by calculating the fluctuation of Bitcoin price from a specific price point at a particular timestamp. For BTC, this is the opening price tag of the coin at the beginning of the day.
Going in more detail, the formula used to calculate the daily volatility of Bitcoin is based on the coin’s standard price deviation.
This standard deviation is calculated by finding the square root (√) of Bitcoin’s price variance.
Having said that, here is how you calculate Bitcoin’s price variance.
- Timestamp the price of Bitcoin at different moments throughout the day(the number of samples taken into consideration is measured as X). Then calculate as follows:
- (Bitcoin’s price at the start of the day – Price at X)^2
- Sum up all the findings = ∑(Bitcoin’s price at the start of the day – Price at X)^2
- Divide your findings by X = ∑(Bitcoin’s opening price – Price at X)^2 /X
Knowing the above, we can now use the following calculation to measure the volatility of Bitcoin:
Bitcoin’s standard deviation = √(∑(Bitcoin’s opening price – Price at X)^2 /X).
How can I best use the Bitcoin Volatility Index?
This tool is great for two reasons:
- To increase your chances of “buying the dip” and thus increase your success of swing trading.
- To verify if your trading-related emotional distress is valid or not – to make data-driven trading decisions.
How does the volatility of Bitcoin affect other cryptocurrencies?
When Bitcoin experiences large price fluctuations that affect its volatility – for example, if a Bitcoin whale sells its coins – the whole market experiences volatility as well.
This happens mainly because of two reasons:
- Bitcoin is the main trading pair for most cryptocurrencies and is thus used the most when trading across exchange platforms
- Bitcoin’s market value currently forms more than 66% of the total cryptocurrency market cap. It is only natural that a large fluctuation in its price will cause investors to create buy/sell orders that include different cryptocurrencies as well.
Over the last 2 years, we have seen two prevailing trends as far as crypto volatility is considered:
- When Bitcoin’s value increases, most “altcoins” do not follow its positive price traction. Instead, they remain stagnant or grow to a lower degree
- When the price of Bitcoin experiences a sudden downturn, most altcoins seem to follow the same direction.
The volatility of Bitcoin in 2020
Remember – volatility is not necessarily a bad thing. Bitcoin be very volatile towards both a positive and negative direction.
That being said, 2020 holds a lot of exciting events that will affect the volatility of Bitcoin’s price.
First off, the BTC network will experience a halving in mining rewards, during the second week of May 2020. This event has been very positive for Bitcoin’s price in the past, and the coin saw a large price appreciation shortly after it.
Second, there are undergoing efforts to bring Bitcoin to the mainstream, making it a viable payment option:
- Facebook is currently dealing with regulatory issues to create its own cryptocurrency – Libra
- Governments and central banks are creating their own blockchain-based tokens
- Jack Dorsey, the founder of Twitter, recently won a patent for an app that will integrate Bitcoin payments into its merchant payment solution – Square
- Brian Armstrong, the founder of Coinbase, recently won a patent for an upcoming project that will help people send BTC to email addresses instead of Bitcoin wallets.
The Bitcoin volatility index is a great tool to use, whether you are an active trader or simply an observer of the market.
While the current high volatility of Bitcoin makes it difficult for institutional investors and merchants to accept it, most investors can increase their profits.
This is a great approach as we wait for more mainstream acceptance of the popular cryptocurrency – and thus a decrease in its volatility.
We hope that this guide helped you understand the mechanics and purpose of the Bitcoin volatility index. If you have anything to add or simply want to ask a question, feel free to leave a comment below.