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Bitcoin Price Risk: Is it Really Parabolic?

Introduction

With more eyes being drawn towards the emerging asset class of cryptocurrencies, we decided to take a closer look at Bitcoin’s price growth to identify trends and patterns left behind in the trail of the current market leader.

Analysing price data from 2010 until now, we measured Bitcoin’s:

  1. Price movement on a linear scale
  2. Price movement on a logarithmic scale
  3. Monthly returns
  4. Volatility
  5. Average trading volume as a percentage of market capitalisation

 

Linear VS Logarithmic – What’s the Difference?

Logarithmic charts are more effective than linear charts when measuring performance over long periods of time. On a linear chart, a jump from 1 to 40 will look tiny compared to a jump from 100 to 200, even though it is a 4000% increase versus a 100% increase. A logarithmic chart fixes this problem.

Logarithmic scale shows movements of equal significance (ie percentage relative to the current price) as equally large. You’ll see that $0.10, $1, $10, $100 and $1000 are equally spaced apart on the logarithmic scale, whereas on a linear scale, distances are equal between $0, $1, $2, $3, $4 etc.

An example of logarithmic measurement in practice is the Richter scale which is used to measure the power of earthquakes. An earthquake measuring 6 on the Richter scale is 10 times larger than an earthquake measuring 5 on the Richter scale.

 

Analysis

 

Daily Price Movement of Bitcoin: Linear Scale

Bitcoin’s price has gone from a minimum of $0.05 in July 2010 to a recent all time high of $19,343, with approximately 90% of this growth occurring since January 2017. Bitcoin appeared to be creating a parabolic price curve as it reached its all time high mid-December. However, the market leader struggled to pass the $20,000 price point, indicating a potential new level of resistance, settling down between $12,000 – $14,000 for the rest of December.

 

Daily Price Movement of Bitcoin: Logarithmic Scale

A logarithmic scale has a different system of displaying this same price data using numbers, or rather, orders of magnitude, which are not evenly spaced on a standard scale. In this graph we are plotting the Bitcoin price on a standard base 10 log. This means that each progressive number on the scale is 10 times greater than the previous number. Historically, it is not uncommon for the Bitcoin price to swing an entire base 10 order of magnitude in a single calendar year. This can be seen on the chart above when Bitcoin crossed two base 10’s in 2011 and one in 2013. The approximate linear log curve denotes an exponential relationship between price and time.

 

Monthly Returns

This chart shows Bitcoin’s monthly returns, from 2010 until the end of 2017, measuring the closing price of the last day of the month and the closing price of the last day of the next month. When plotting a trendline, we can see that the average monthly return is decreasing. We are no longer seeing monthly returns of 350% such as those experienced by Bitcoin holders in 2011 or 2013. Instead, we are now seeing 50-100% maximum monthly returns, suggesting a stabilisation between Bitcoin’s ratio of risk and reward.

 

Volatility

By taking the standard deviation of the daily closing price for preceding 30 day windows, we can clearly see that volatility has been decreasing since 2010, reaching a high above 16% in 2011. From January 2017 onwards we can see that volatility is on a slightly increasing trend, with volatility levels currently sitting above 6%. This average monthly 6% swing has been beneficial to day traders capitalizing on the price movements.

 

Average Bitcoin Trading Volume as a % of Market Capitalisation

The chart above shows Bitcoin’s average trading volume across all of the major exchanges, expressed as a percentage of Bitcoin’s market cap. Similar to volatility, we can see that the average trading volume is trending slightly downwards as Bitcoin’s market cap continues to grow in size.

 

Conclusion

Plotting Bitcoin’s price on a linear scale portrays a picture of explosive growth. With Bitcoin trending upwards in a near parabolic state, the linear chart is favoured by sensationalist media articles as they describe the frenzied mania enshrouding Bitcoin and the rest of the cryptocurrency market. The logarithmic chart for Bitcoin paints a far more suitable picture, one that displays a relatively stable pattern of growth for Bitcoin. Charting Bitcoin’s monthly returns showed that returns are actually trending downwards, in line with an overall reduction in price volatility. As volatility is trending downwards, so too are monthly returns, constricting to more stable levels in line with the reduced price risk. It therefore appears that although monthly returns are trending downwards, Bitcoin is achieving greater levels of stability as a digital asset, no longer experiencing the extremely wild swings such as those seen in 2011 and 2013. As retail and institutional interest in Bitcoin continues to grow, it is important to look beyond the linear price chart to clean your lens as a prudent investor and gain a clearer perspective.

 

 

 

 

 

 

 

 

 

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