Cryptocurrency Part 3: Let’s Talk About Volatility

It’s easier to hit a home run when the pitcher throws with more velocity.  I remember my dad telling me this when I was in little league.  Honestly, I remember being terrified of someone throwing the ball hard (what if it hit me!?).  I think it was my dad’s way of easing my mind.  Oh yeah, it happens to be true as well—my dad was a history teacher, so his science lessons were totally accidental. 

If you watch professional baseball these days, the new buzz phrase is “exit velocity”—the speed at which the ball travels off of the bat.  What creates a high exit velocity is a combination of the pitcher’s ability to throw hard and the batter’s ability to swing hard.  If the pitcher lobbed one in there underhand, your exit velocity capabilities diminish considerably. 

Why am I talking about baseball?  And how long will I continue with this analogy? 

I’m glad you (I?) asked.   

The concept holds true in an emerging asset class like cryptocurrency (for the sake of this post, I’ll be talking almost exclusively about Bitcoin).  Only, there aren’t pitchers and hitters; there are buyers and sellers.  And instead of velocity, there’s volatility.   

Often, the most volatile assets have the potential to have the largest rewards.  It just takes more hutzpah to hang in there.  If you’ve paid any attention to financial news recently, you’ve seen that the price of Bitcoin dropped from a little over $63,000 per coin to below $35,000 per coin—a massive 60% drop.  It got me thinking about how this compares to other asset classes (stocks in particular).  Luckily the folks over at Ecoinometrics did some work on just this topic.  See the chart below. 

Chart, scatter chart

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Apple, Amazon, Microsoft, and others all weathered drawdowns of over 75% at times.  Those were likely early days in the companies histories, but we’re early days (I believe) in cryptocurrency.  So is the volatility in Bitcoin, for example, so outlandish?  Not as much anymore.   

Now, I’m not suggesting that Bitcoin is the next Apple (though the market caps aren’t as far off as you might think).  I think it may come off as a bit disingenuous to compare a company with profits, products, and consumers to Bitcoin.  But I’ll remind you that most investments, however structured, follow a similar pattern.  Why?  Because the buyers and sellers of investments are human beings and human beings tend to follow a psychological pattern when it comes to investing.   

And can we talk about gold for a minute?  Bitcoin is often compared to gold as a store of value that runs contrary to the value of the U.S. dollar and can act as an inflation hedge.  But take a look at the chart below. 

Chart, scatter chart

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Some pundits have talked about Bitcoin being in extended bear markets in the past—it’s true, sometimes as long as a couple of years.  But gold, back in the early 80s, made an all time high, and then didn’t reach a new high until 27 YEARS later.   

So, the level of volatility can have a profound impact on the rate of return of the underlying investment—this is borne out time and time again.  To be clear, a high level of volatility is not a guarantee of eventual positive performance, so buyer beware.   

If you haven’t noticed already, I’m a believer in certain cryptocurrencies—I’d encourage you to read my previous two posts if you haven’t already.  So, when I see volatility of this nature, I remind myself that this type of volatility is typical in the infancy stages of a new asset class, new company, etc. and can pay off immensely if you’re able to hang in there. 

I’ll touch on where I believe cryptocurrencies fit into a diversified in a future post.  Until then, keep your eye on the ball and stay in the batter’s box. 

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