Volatility measures the variance of the price of a certain financial instrument within a certain period of time. It is commonly associated with the risk level of the instrument, a highly volatile instrument is regarded as risky and a less volatile instrument as less risky.
Therefore, it is important to understand the volatility of bitcoin and other cryptocurrencies if you are looking to invest or trade in the cryptocurrency space.
Here are the most important take-aways of the bitcoin volatility analysis based on our data:
1. Bitcoin is the least volatile cryptocurrency
Bitcoin weekly volatility reached up to 60% per annum during the previous year (Figure1), but other coin pairs saw even bigger swings. Bitcoin is definitely the most liquid coin, its order books show the deepest sell and buy offers, therefore a big trade will have a smaller price impact, hence a smaller price volatility. Bitcoin is, however, still more volatile than any fiat currency pairs.
When comparing Bitcoin trading versus fiat currencies, we observe that BTC versus CNY is the most volatile market (Figure2). This is mainly due to the previously zero trading fees on Chinese exchanges that bumped up volume.
Figure1: Volatility of most traded currency pairs
Figure2: Volatility of BTC versus most traded currencies
2. High volatility most commonly coincides with high volume and price drop
It might seem quite intuitive for you that high volatility coincides with high volume and price drop. When markets panic, prices can drop massively that brings in even more sell orders as everyone tries to close their positions. It is still important to note the relationship of these three factors and their co-movement (Figure 3 and 4).
If we divide the volatility by the volume traded, we get that in average, an additional 1000 BTC trading would result in 0.25% increase in volatility. In terms of price impact, it can be an upward or downward move, but in all cases the price will move.
Figure 3: Volatility and price of BTC_USD
Figure 4: Volatility and volume of BTC_USD
3. Bitcoin price moves together with other cryptocurrency prices
Bitcoin price over the last 1 year was highly correlated with DASH and XMR (Figure 5), but shows no correlation with Ethereum. We can assume that Bitcoin trading activities boost volumes of other coins as well, and it might well be that news shocks on Bitcoin may affect prices of other coins.
Figure 5: Price correlation of most traded coins against USD
4. Bitcoin volatility can be traded
Volatility is a derivative product of an underlying financial instrument and it can be traded via options. Options are products that pay when a certain price condition is met (for example when the price of the underlying product hits an upper barrier).
Options are used for speculation (you expect Bitcoin price to drop under 950 USD and want to trade it) or hedging (you are paying your employees in Bitcoin but earn in USD, so want to set the limit of the conversion rate).
Currently there are only a few places where you can trade with options on Bitcoin. If you trade with options, you might have recognised something called the implied volatility.
Implied volatility is a parameter calculated (implied) from the option pricing equation (Black-Scholes). Although it is also called volatility, it is different from the volatility we calculated above (from now we call it the realised volatility).
It is important to watch out for this parameter, as it shows the market sentiment of the underlying product.
The higher the implied volatility, the more expensive is the call option. Currently BTC_USD call options with expiry March 31 2017 listed on Deribit show an average implied volatility of 85% on the bid side and 130% on the ask side (compared to a max realised volatility of 60% of last year).
It is common to see a premium on implied volatilities (compared to realised volatility), as option sellers bear a risk of infinite loss.
In general, the more liquid the derivatives markets are, the more deeply liquid the underlying product is (or needs to be). The appearance of options of Bitcoin shows that liquidity of Bitcoin increased.
5. Bitcoin has the potential to match the volatility of major fiat currencies
Bitcoin did not do too bad last year compared to fiat currencies. In average, daily returns were positive, volatility was still the highest, but an almost 8% drop in GBP value does not seem a lot better than the 15% drop of BTC.
Table: Currency versus USD statistics for 2016