Bitcoin is Volatile
Over the past year the price of Bitcoin has seen significant growth, capturing the attention of a range of investors. However, the ascent hasn't been without periods of intense volatility where the price has fallen rapidly. Such fluctuations serve as a reminder that this investment does have inherent risks and is not for everyone. However, adopting a strategic approach that uses patience and caution could pave the way for long-term success in the Bitcoin market.
Bitcoin regularly cycles in and out of the news, with stories flooding headlines whenever its price makes a significant move – whether that move is positive or negative. News stories often frown upon Bitcoin’s volatility, highlighting it as a serious risk and using this as a proof point that one day Bitcoin will disappear and investors in Bitcoin will lose out.
Some of this is fair enough, Bitcoin is a highly volatile asset, there’s no arguing that point. However, just because it is volatile doesn’t mean that is not an investable asset, and volatility alone definitely does not mean that it is going to zero.
If you are a Bitcoin investor, you need to go in with your eyes wide open. You should expect this volatility and when it starts to get scary, you need to close your eyes and hang on for the ride. The biggest mistake you can make is changing your mind and looking to get out when the price of Bitcoin sinks. You will lock in the losses and will miss out if the price of Bitcoin recovers.
Why is Bitcoin volatile?
The problem with Bitcoin is its size. It has a market capitalisation of only US$1.2trillion. While that may sound large it is tiny in the scheme of investable assets. The S&P500 has a market capitalisation of US$44 trillion and Microsoft alone is worth almost 3 times as much as Bitcoin at $3.1 trillion. It’s a pretty small asset in its own right.
Added to this, it is estimated that up to 70% of all bitcoin is held by long term holders, so not really traded.
All of this means two things
there is a relatively small volume of bitcoin that is available to be bought when investors desperately want to get their hands on some more to take advantage of a rapidly appreciating price. This lack of supply pushes the price up
There is not a deep pool of investors to pick up the slack when the tide turns and people start selling. This means that when sentiment turns, it can push the price down a long way quickly as there are no buyers of last resort
This is an old-fashioned liquidity trap. Lots of people trying to purchase a small amount of coins push the price up in the upswing, and when things turn, people rush to the gates, but no one is there to pick up the slack.
Being aware of this and understanding this phenomenon can help you as an investor. If you are a believer in Bitcoin and intend to hold it for the longer term, then you can take advantage of the volatility. With KiwiSaver you will keep on investing in both the good and the bad times.
The recent launch of the ETF’s in the US has been an old-fashioned liquidity squeeze, lots of people have been trying to get into the asset class which has resulted in demand outstripping supply. These funds have driven net new investment of over US$20b in the space of the first 6 weeks which is massive for a smallish and illiquid asset like Bitcoin. Hence why the price has risen back to all-time highs.
Thinking about the Bitcoin cycles
The bouts of volatility (or sentiment shifts) can last from days through to years. There is no question, crypto is polarising, and when it's bad in crypto land, media and traditional finance people get on the bandwagon and quickly predict Bitcoin’s impending doom. This is why negative sentiment can last for years and has historically led to a crypto winter every three or four years.
Over the past 15 years, Bitcoin has gone through 4 different growth cycles, each lasting approximately 3-4 years. Typically, the price of Bitcoin increases for the first 2-3 years of the cycle (as shown by the green in figure 1), followed by 1 year of lows in the price (shown by the red in figure 1). This predictability, much like the volatility, can also be attributed to the halving. You might think of Bitcoin’s long-term cycles like the ebb and flow of the tide; however, it is not an exact formula.
Fig. 1. Bitcoin’s 4-year cycles, highlighting uptrends and downtrends; “The Bitcoin 16 Year Cycle, And Its Correlation To The Internet Bubble”, 10 Oct. 2023, https://www.nasdaq.com/articles/the-bitcoin-16-year-cycle-and-its-correlation-to-the-internet-bubble
The Key to Success with Bitcoin: Patience and Caution
While Bitcoin’s seemingly predictable cycles are enticing for many investors it’s infamous volatility is the reason you need to be cautious when investing with Bitcoin and be thoughtful about your strategy. One simply can’t know exactly when or how much the value of Bitcoin will increase or decrease.
While we can’t predict the short-term shifts in price, we can look at the long-term historical data on Bitcoin’s price and analyse the patterns. This is where Bitcoin’s potential really shines; from March 2011 to March 2021, the value of Bitcoin increased 230%. However, Bitcoin also experienced two significant price slumps during the same 10 years. If investors had sold during these lows, they would have locked in their losses and missed out on the significant gains realised over the 10-year period.
This highlights the importance of taking a long-term view when investing with Bitcoin. Don’t try to day trade or predict the cycles, as there’s a good chance, you’ll become stressed by the short-term data and sell too early. So, take the long-term view and when the price is down, remember to hold on to your Bitcoin and ride out the wave, you’ll retain the potential to realise more gains in the future.
How to Make Bitcoin’s Downtrends Easier
Of course, there are certain ways to manage your portfolio that make the lows hurt less. Anything to mitigate your risk, such as low exposure, will help to ensure your overall portfolio isn’t hit too hard by dips in Bitcoin’s value. At Kōura Wealth, we typically recommend investors only allocate 3% of their overall portfolio to Bitcoin. This is based on the optimal portfolio theory, which balances assets that grow the portfolio against the risk posed. However, we do allow investors to invest up to 10% should they choose.
Rebalancing your portfolio allocation regularly can also help protect your gains. As Bitcoin is an asset that can suddenly grow much faster than your other investments, it can quickly outgrow the percent portion of your portfolio that you’ve allocated to it. If you set your portfolio to hold 3% of its value in Bitcoin, this fund’s growth could outpace your other funds. Once your bitcoin allocation grows to a certain percentage of your portfolio, you can redistribute the gains across your other assets. This way, you’ve realised your gains by holding the value of your portfolio in funds that are less volatile, and you’ve protected those funds against the short-term losses. At Koura Wealth, we rebalance your portfolio every 6 months or whenever your allocation reaches 15%.
Dollar-cost averaging is another strategy that works well with Bitcoin, as you continue to buy regardless of swings up or down in the price. This usually allows investors to buy assets at a more favourable cost, as they continue purchasing assets through any lows. This is a strategy that can be achieved easily with KiwiSaver thanks to the regular contributions made under the scheme.
Conclusion
Bitcoin will always be a volatile asset, in part due to the way this asset is built, and this is one of the things that makes it so unique. At the same time, this volatility means it can be a risky asset to hold. If investors feel they can weather the ebbs and flows of Bitcoin’s price volatility, they should still take a long-term view and not make changes based on short-term data. Investors should also only invest a small portion of their portfolio into Bitcoin and regularly rebalance their portfolio. These strategies, along with a long-term investment strategy can help investors realise their returns with Bitcoin and learn to ride the wave of its volatility.
Disclaimers
Cryptocurrencies are highly volatile assets and not suitable for everyone. It is critical to understand that cryptocurrencies still have an uncertain future and are therefore not appropriate for all KiwiSaver members. Before investing part of your KiwiSaver balance in cryptocurrency, it is crucial that you have a clear understanding of all the associated risks: https://shorturl.at/irERY
Past performance is not a guarantee of future returns.
Members can only allocate a maximum of 10% of their portfolio to our Carbon Neutral Cryptocurrency Fund.
Kōura Wealth is the issuer of the koura KiwiSaver Scheme. View our PDS at kourawealth.co.nz/documents