Bitcoin Market: Volatility, Regulation, and Economic Impact

Now 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 analyse, to some extent, some of the patterns and factors contributing to these price movements and assess how the reduction in supply influences market behaviour, investor sentiment and long-term price trends.

Perhaps such rallies could be attributed to some positive regulatory developments in various countries, providing a more favourable environment for cryptocurrency trading and usage. The anticipation of potential approval for spot Bitcoin Exchange-Traded Funds (ETFs) in the United States has generated excitement among investors, as such approval would likely bring a greater degree of mainstream acceptance and liquidity to the market.

However, there are many concerns regarding regulatory scrutiny, market manipulation and the volatility inherent in cryptocurrencies that might affect the approval process and the subsequent performance of Bitcoin ETFs.

Bitcoin: A Retail-Driven Market Vulnerable to Economic Stress and Regulatory Uncertainty

Unlike equities, which are supported by institutional investments and cushioned 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 susceptible to economic stress, as its liquidity is ineffective to manage large, panic-induced flows without causing significant price disruptions.

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 hinting at tighter crypto regulations, or legal actions such as criminal enforcement or bankruptcies of major players, can provoke sharp, disproportionate volatility.

“Traditional assets like gold and stocks, on the other hand, are regulated within well-established frameworks that typically shield them more from uncertainty and exposure to individual bad actors. Economic variables such as inflation or interest rate adjustments influence asset classes differently. Bitcoin’s reactions are more erratic, swayed heavily by investor sentiment and speculative trading.”

Structural breaks in market dynamics, occurring around major global events, lead to shifts in trading behaviors and market perceptions, further influencing Bitcoin’s price fluctuations.

The perceived role of Bitcoin as a diversification tool during market stress and its volatility, as it attracts attention from fund managers and investors looking to mitigate 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, pointing to the presence of irrational behaviour in the crypto market.

The Impact of Global Economic Events on Bitcoin

Until 2021, Bitcoin and cryptocurrencies at large were considered uncorrelated with traditional assets like stocks and bonds.

“Many research articles were dedicated to the role of Bitcoin as a hedge or a safe haven from a portfolio perspective. Given the absence of correlation, Bitcoin could be valuable used as a diversifier. However, in 2022, the successive interest rate hikes by many central banks and the fall of FTX led to a fall in both the financial markets and cryptocurrencies. Bitcoin’s sharp decrease (-70%) was comparable to the decrease of the NASDAQ index,” says Finance Professor Nathalie Janson, NEOMA Business School.

Kate Leaman, Chief Market Analyst at AvaTrade, adds: “Unlike traditional assets, Bitcoin responds to global economic events with a unique sensitivity.

“For example, when traditional markets face uncertainty, investors might turn to gold as a ‘safe haven,’ which usually stabilizes its price. However, Bitcoin, perceived by some as digital gold, often experiences sharp price movements under the same conditions due to its speculative nature and the diverse sentiments of its global investor base.”

The relationship between gold and Bitcoin is also significant since gold is considered a store of value and a safe haven, showing a low correlation with traditional assets like 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 costly to produce/extract as they require energy.

The Role of Regulatory Changes in Bitcoin’s Volatility

“Regulatory changes affect Bitcoin’s volatility significantly,” says Nathalie. “For instance, when China decided to forbid any Bitcoin-related activities, including mining, in April 2021, it led to a major drop in Bitcoin price from approximately US$64,000 to US$48,000.

“This decision was not only negatively affecting 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 kept increasing until March 2024.”

James Sullivan, Group General Counsel and UK General Manager of Bitstamp, adds: “Regulators play a vital role in investor Bitcoin perception. Crypto is not regulated but regulatory oversight of the sector and market participants positively influences Bitcoin’s price by fostering mainstream acceptance and investor confidence.

“By providing a clear legal framework, regulation that aligns more closely with traditional finance can instil greater confidence in both retail and institutional investors. Regulatory certainty often catalyzes greater participation in the market, leading to increased demand and, consequently, upward pressure on prices.”

Without the institutional safeguards that traditional securities have, Bitcoin is especially vulnerable to regulatory changes. Recent law changes allowed for the introduction of Bitcoin ETFs, leading some to believe that this would result in significant institutional investments. However, it seems that this anticipated institutional demand did not materialize, and the price surge following the launch of Bitcoin ETFs has since diminished.

The Effect of Large Holders on Bitcoin’s Price Stability

Whales exert a disproportionate influence on Bitcoin’s price due to the concentration of substantial holdings among a few individuals. Their capacity to conduct large trades can cause significant price swings because of the market’s relatively low liquidity.

Whether buying or selling, these transactions can set off chain reactions across the market, either driving prices up with large purchases or causing steep drops with significant sell-offs.

Traders closely monitor whale wallet activities for signs of impending large-scale transactions.

This anticipation or reaction can increase volatility, as even rumours or perceptions of a whale’s potential market moves can lead to notable price fluctuations.

Jonathon Hughes, Head of Emerging Tech at MDRx, adds: “Historically, Bitcoin whales have demonstrated an ability to impact Bitcoin prices. Their network of wallets are constantly tracked, meaning that a movement in any direction can trigger wider participation.

“Whales are aware of this and influence the market to match their trading strategy, such as short selling, pump & dump, and stop loss hunting. Many big whales are aligned with the core principle of the technology and aid in defending the market position of the asset.”

Technological Developments and Bitcoin’s Price Stability

Developments like the Lightning Network, which facilitates faster and cheaper transactions, aim to improve Bitcoin’s functionality for trade. However, while this scalability may enhance its general utility, it does not directly address the core volatility that undermines its utility beyond speculation.

Introducing smart contract capabilities to Bitcoin could theoretically expand its use cases beyond trading, mirroring efforts seen on platforms like Ethereum.

However, increasing Bitcoin’s utility through these means would not necessarily quell its price volatility and could even introduce new avenues for speculative behavior.

Zachary Michaelson comments: “Advances in cryptographic security and wallet technologies can bolster investor confidence and might mitigate the chances of certain types of panic-driven sell-offs. Nevertheless, these measures primarily enhance security rather than directly moderating the wild price swings beyond certain very specific scenarios.”

The Evolution of Bitcoin’s Volatility

While there’s a trickle of serious institutional capital into Bitcoin, broader institutional engagement remains tepid. The critical factor here isn’t just participation but the nature of it—whether institutions invest in long-term holdings or short-term speculative gains.

Institutional involvement could either mitigate or exacerbate volatility, depending on the nature of the participation, and right now it seems tilted toward exacerbating volatility, not stabilizing the market.

Professor Samuel Ouzan says: “The degree of connectedness among cryptocurrencies changes over time and is higher during periods of market uncertainty.

“Increased connectedness leads to greater volatility spillovers, implying that during turbulent times, the interplay between cryptocurrencies becomes more pronounced, impacting 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 diminish and operational costs escalate, miners might be compelled to sell their holdings to cover expenses, particularly around halving events.

“This necessity can introduce additional volatility, affecting supply dynamics on exchanges. The decreasing incentive to mine could lead to shifts in the miner population, further impacting Bitcoin’s price stability.”

If global interest rates remain high and ultimately result in a broad deleveraging event, this evaporation of speculative capital and demand for liquidity could be devastating to Bitcoin’s price and volatility.

Ultimately, it is unlikely that Bitcoin will 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 characteristic of Bitcoin for the foreseeable future.

Kapil Dhiman, Co-founder & CEO, Quranium says: “Overall, while Bitcoin will likely remain volatile in the short term, these combined efforts in enhancing 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 adaptation essential for stakeholders in the cryptocurrency space.”

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