Bitcoin Price Volatility Symptom Of Liquidity

On Oct 17, 2021

In March 2020, major stock market indexes saw some of the worst price collapses in decades, as markets confronted the realities of the COVID-19 pandemic. Bitcoin was no exception to these economic strains. Having traded as high as $10,000 in mid-February 2020, bitcoin’s price collapsed to below $4,000 by mid-March, including a 30% drop in a day.

Fear caused a flight to cash in across the board, from domestic to international traders, large-cap to small-cap assets, gold to bitcoin. Markets fell, and bitcoin did too.

It was clear that in the face of market shocks, bitcoin’s unique attributes, as listed below, could make it more vulnerable to price collapses as compared to other asset classes:

Trading 24/7/365
Offering final, global settlement within minutes
Accommodating liquidity across all major currency pairs
Lacking a central authority, which can restrict or influence trading behaviors

These attributes are unprecedented among asset classes and help make the case for bitcoin to be regarded as the most liquid asset in the world.

How many assets can offer final settlement, on billions of dollars in value, in minutes, anytime, any day, anywhere?

Although other asset classes have larger market caps and higher daily trade volumes, their limitations in terms of trading hours, holidays, and “circuit breakers” become readily apparent now that an alternative exists. Liquidity is no longer limited to business hours.

Bitcoin Price Volatility Not About Faith, But Liquidity

In a globally-interconnected world where market information travels in seconds rather than days, being able to re-position regardless of time or place is a significant advantage.

As bitcoin continues to grow, portfolio managers will increasingly view their asset allocations along the axis of those limited by legacy constraints (trading hours, holidays, circuit breakers, policy decisions, etc…) and those that are unconstrained. In times of crisis, when liquidity is needed immediately, having a portfolio allocation that is unconstrained in its liquidity is valuable.

Bitcoin’s emerging status as the world’s most liquid asset carries implications.

As popular adoption of bitcoin continues apace, and businesses begin to put it on their balance sheets, there is an ever-greater surface area forbBitcoin to be bought and sold at a moment’s notice. When cash is urgently needed to cover short-term liabilities, bitcoin will increasingly be available as the first option to provide liquidity. Bitcoin could offer a liquidity lifeboat in worst-case scenarios.

This type of crisis selling may not necessarily be out of strategic interest or desire to leave bitcoin, rather it may simply occur due to the fact that bitcoin is the most liquid asset, thereby offering an unconstrained flight to cash when needed the most. It goes without saying that retail panic selling or ambitious traders looking to sell high and buy low also can contribute to rapid price declines in bitcoin.