Bitcoin is almost undoubtedly the most popular and successful of the virtual currencies – many of which have boomed in recent months. More hardware and software products are emerging to accommodate new users. While it becomes increasingly easy to get involved in trading virtual currency, a concern remains for many: volatility.
Volatility effects Bitcoin in particular because it is traded as both a currency and a commodity – it is also not “pegged” to another currency – as a result it is driven vigorously by market demand, which can at times be very turbulent. In fact, the lowest price in 2013 was $13 per BTC and the highest was $260 – a roughly 2,000% difference. How could we ever predict such volatile movements?!
This might not be all that it appears. Some analysis has been done that might suggest otherwise. Curiously, that Bitcoin would seem to follow the dollar.
You wouldn’t be wrong to expect that because Bitcoin is not affiliated with any particular state, that it would increase in value as inflation intensifies with standard currencies. This isn’t the case however – we can see this because Bitcoin’s behavior isn’t at all correlated with gold, which is a common “inflation hedge”. The below chart illustrates the relationship (or lack thereof) between Bitcoin and gold. A Pearson correlation finds that there is a -0.4 correlation, put simply: a weak relationship that moves in opposite directions, gold moves up, BTC moves down (but barely!).
What is interesting is that when the same correlation is applied to BTC v. the US Dollar, a much more clear relationship can be observed. In fact, a day-to-day correlation of 0.76 is noted (same direction, reasonably strong). Move the USD data three days forward, and we find that the correlation increased to 0.89 (same direction, strong). While such a correlation doesn’t endow us with true predictive power, it is interesting to consider and certainly suggests some kind of underlying relationship between the two.
There are a few reasons why this might be the case. The USD is (relatively speaking) a fairly low-risk currency, with traders often boosting its value in more turbulent times. In addition to this, about 70% of BTC trading is conducted in USD, which would mean that when USD increases in value relative to any other currencies, so too does BTC.
The take away message here is fairly simple, for now, the USD might serve as a relatively useful comparison to determine the trends and movements of Bitcoin. While there is no guarantee against Bitcoin’s extraordinary volatility, as more traders enter the market, and as platforms stabilize, so too will the day-to-day behavior of Bitcoin. In the future, it will be interesting to see if Bitcoin is influenced more substantially by other currencies as market dynamics change, and as new countries adopt this exciting virtual currency.