Bitcoin's price has been on a rollercoaster ride of late. Here's the weekly price of Bitcoin over the past four weeks:
December 25, 2020: $24,665
January 1, 2021: $29,374
January 8, 2021: $40,798
January 15, 2021: $36,825
Over this four week period, the price of Bitcoin has been as low as $23,464 and as high as $41,947. It has had days of 10% gains followed by 10% losses. Here's what it looks like in chart form:
For people who have been thinking about buying Bitcoin, this volatility can be unsettling. For those that recently bought Bitcoin, it can feel downright scary.
When experiencing such volatility, it's important to put things in perspective. Short-term volatility primarily matters to those with a short-term mindset. Rather than focus on the next day, week, or month, we prefer to look at Bitcoin as a longer-term holding. If we zoom out to the one year chart, the volatility over the past four weeks doesn't seem quite as scary.
The recent volatility feels even less menacing if we zoom out further to a five year timeframe:
Even after zooming out, however, those new to Bitcoin may still feel uneasy about how much the price moves in a single week, day, or even hour. One of the most common questions with regards to Bitcoin is: how can something as volatile as Bitcoin be considered a store of value? To begin to deal with Bitcoin's drastic price swings, we first need to first debunk a common misconception about volatility.
Volatility Is Not Risk
"Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever." - Nassim Nicholas Taleb
Many in the financial world simply assume that volatility equals risk; in other words, higher volatility means higher risk, and lower volatility translates to stability. If the COVID-19 shock taught us anything, it is that low volatility does not equal stability. For the decade preceding COVID-19, the US unemployment rate was not very volatile. If we had used volatility as a metric for risk, we would have assumed zero risk of unemployment going significantly up. Below is a chart of the (very stable looking) US unemployment rate of the past 10 years, up until just before the COVID-19 shock:
As soon as COVID-19 hit, all previous assumptions about volatility were rendered completely useless, as seen in the full graph of US unemployment:
The above example illustrates why we should never assume low volatility equates to stability. The flip side is also true: higher volatility does not mean that something is more risky. In fact, higher volatility can often decrease risk over the long-run. For example, a highly active person's heart rate will be quite volatile, which can actually lead to a healthier and longer life. In the case of heart rates, it is the lack of volatility that is risky: a sedentary person with zero heart rate volatility is at far higher risk of disease and premature death.
Whether it's the US analyzing unemployment risk before March 2020, or an investor watching on the sidelines for 6 months while Bitcoin shoots up from $12,000 to $40,000, those conflating volatility and risk are often ill-prepared to deal with sudden change. Citing volatility as the source of Bitcoin's risk is akin to citing the stability of the unemployment rate as the reason that it won't drastically shift up or down.
While we've seen that volatility is not the same thing as risk, Bitcoin's dramatic price swings are still important to consider when deciding how much Bitcoin to hold and how long to hold it. Those trying to time the market for short-term gains are in a much trickier situation than those viewing Bitcoin as a longer-term store of value.
Timeframe Matters - A Lot
Many Bitcoin critics claim that it cannot be a store of value due to its extreme volatility. However, what is and is not a good store of value depends on the timeframe that you need to store your value. If you need to store your value for a single day, then Bitcoin is a poor store of value. The price could easily go down 20% or more on any given day. But what if you're looking to store the fruits of your labor over multiple years?
If your goal is to store value to be available four years from today, then you don't really care what the value is after one day, one month, or even one year. Your goal is to wake up four years from now with the same purchasing power you have today (or more). Which of the following two scenarios would you prefer? The first table shows the results after one year, while the second table shows the results of the same investments after four years.
If you had just stopped after one year, you'd certainly prefer Scenario 2. However, when you zoom out to the full four years, Scenario 1 is clearly superior. Scenario 1 is pulled from Bitcoin's historical worst returns over a one year and four year time period. Scenario 2 is from gold's best returns over a one year and four year time period (starting in 1979).
Gold is widely viewed as the premier store of value asset. While it certainly has smaller short-term losses when compared to Bitcoin, gold's returns over a multi-year time frame are dwarfed by Bitcoin, no matter how you slice it. In the tables below, we can see how Bitcoin (since 2014), gold (since 1979), and the US dollar (since 1970) stack up:
Gold is often seen as a much more conservative investment when compared to Bitcoin. However, it has seen a 3 year period with a 43% drawdown and a 4 year period where its price dropped by over half. How does the highly volatile Bitcoin compare? Since entering the mainstream in 2014, Bitcoins' worst 3 year return was 0%. Bitcoin's worst 4 year return is +839%. In other words, if you bought and held Bitcoin for any four year period since 2014, the absolute worst you could have done would be to more than 8x your initial investment. While gold has been a better short-term store of value when compared to Bitcoin, the US dollar has performed similarly to gold when storing value over shorter time periods. Of course, the US dollar is nearly guaranteed to lose value over multi-year periods due to inflation, making it the worst long-term store of value of the three.
In the grand scheme of things, four years is not all that long. While Bitcoin's profile to-date looks superior to gold's, history does not guarantee future results. Bitcoin is still in its early adoption stage, while gold has been around for thousands of years. However, those who claim that Bitcoin has not been a store of value due to its volatility are ignoring reality. For those who have held Bitcoin as a store of value asset for three years or more, it has performed undeniably well. While this is not certain to hold up in the future, the case for Bitcoin as a long-term store of value continues to get stronger with each passing year.
Time is the ultimate stressor that will determine whether or not Bitcoin becomes the global reserve currency. Those who believe in the potential of Bitcoin will have to put up with immense amounts of volatility. But, as we've seen, volatility is not equal to risk. Further, the definition of risk looks very different depending on your goals and timeframe. While short-term speculators are obsessed with price volatility, longer-term holders are much more focused on the properties of Bitcoin that have led to its vastly increasing adoption over the past decade. Short-term thinkers worry about what the price will be tomorrow. Meanwhile, those with long-term conviction ask: 'what could go wrong with the core attributes of Bitcoin?' They understand that Bitcoin's daily or yearly volatility is irrelevant to the risk of owning it for the long-run. Rather, the ultimate fate of Bitcoin rests on its resilience to challenges, along with its ability to survive and adapt against future unknowns.
US Unemployment chart: https://tradingeconomics.com/united-states/unemployment-rate
Daily Gold price: https://www.gold.org/goldhub/data/gold-prices
US Dollar Inflation Rate: https://www.usinflationcalculator.com/inflation/historical-inflation-rates/
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