Seven years on, bitcoin still remains the largest digital currency by market capitalization. While bitcoin may have been the most volatile currency, it has since ceded that mantle to up-and-coming altcoins. The transformation of bitcoin from a volatile experiment, to a “stable” form of electronic money is illustrated in Figure 1. The graph plots the 90-day moving average market capitalization of bitcoin against its 90-day realized volatility. Volatility peaked alongside the market cap during the 2013 bubble. Over the past three years, the market cap fell substantially, then surpassed the 2013 high earlier this year. During the same period, volatility fell and continued falling. The holy grail for many users is a digital currency that has a growing market cap and falling price volatility. A large market cap helps improve liquidity and reduce transaction costs. Falling volatility means that bitcoin can retain its value for longer periods of time. That helps facilitate its adoption in online commerce and as an asset for savings. Bitcoin’s march toward reserve status is not welcomed by all. Many speculators, who account for a significant portion of trading volumes, prefer very volatile digital currencies. Short-term trades with high leverage can yield stupendous returns. As bitcoin’s volatility falls, it becomes boring and speculators search for the next hot altcoin. The solution to a boring coin is more leverage. Given the increasing liquidity, leverage offered by trading platforms will increase, and retain the attention of speculators. If the volatility keeps falling, 500x and 1,000x leveraged trading will become increasingly popular. Regardless of the form, increased leveraged trading via derivatives bleeds into the spot market. Market makers must buy or sell the underlying asset to remain hedged and earn the bid/ask spread. Increased spot trading volumes help commercial users of bitcoin reduce their transaction costs. More commercial […]
