How Bitcoin Volatility Affects Its Use As A Medium Of Exchange

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Last Updated December 13th 2022
4 Min Read

Bitcoin volatility affects its use as an exchange medium. Here's how Bitcoin price fluctuations affect its function as an exchange medium. 

Satoshi Nakamoto introduced Bitcoin in a whitepaper in 2008 before launching it in 2009. This whitepaper titled "Bitcoin: A Peer-to-Peer Electronic Cash System" explained that Bitcoin is a decentralized digital currency that does not rely on any central authority for its issuance or regulation. Thus, people could use Bitcoin to transact or pay for items and services, as they do with fiat money, only that Bitcoin could never be physical or under any central authority's regulation. Also, this means the only way to obtain Bitcoin is from other people who possess it, typically through online exchanges and marketplaces.

Initially, people could only mine Bitcoin. However, you can trade Bitcoin with Bitcoin Prime, eventually emerged, allowing people to purchase and sell Bitcoin. And this gave Bitcoin another purpose other than what Nakamoto intended. Many people began perceiving Bitcoin as a commodity or an asset they could buy and hold, waiting for the price to increase and selling it at a higher price for profits.

And like with any asset, investing in Bitcoin has some risks. Illiquidity, a relatively small market, and price speculation make Bitcoin a highly volatile asset. Today, most merchants decline Bitcoin payments due to the cryptocurrency's value fluctuations, which happen over short periods. As such, if an individual were to transact goods and services using Bitcoin, they may find themselves in a situation where their payments become larger or smaller than intended as the value of Bitcoin moves.

Understanding Bitcoin Volatility

To better understand how well Bitcoin fares as a medium of exchange, researchers have studied its volatility and liquidity. The volatility of an asset is a measure of how much its price fluctuates over time. High volatility means prices can change drastically in a short period, while low volatility implies small changes over more extended periods.

Researchers have found that Bitcoin's volatility has decreased since 2010 compared to traditional currencies like the US dollar. But other studies suggest it's still significantly higher than most fiat currencies, making it difficult for merchants to accept payments with Bitcoin for their goods and services due to uncertainty around its future value.

Liquidity is another critical factor. It measures how quickly and easily people can convert an asset into cash without affecting the price. Bitcoin's liquidity has been increasing rapidly, with more crypto exchanges emerging and investors trading large amounts of money. And this indicates that Bitcoin could become an effective medium of exchange if its volatility continues to decline.

Can Bitcoin Volatility Decrease?

Two main factors cause Bitcoin's volatility. The first is the market structure, where speculation and arbitrage opportunities affect prices. And the second factor influencing Bitcoin's volatility is its limited acceptance as a payment method. As more merchants accept Bitcoin payments and its usage increases, its price fluctuations may reduce over time.

So far, Bitcoin's volatility has decreased in recent years but remains higher than most fiat currencies making it difficult for merchants to accept payments with this cryptocurrency. But we see an increase in the adoption of Bitcoin as a medium of exchange, with more people using it for daily transactions. In that case, its volatility could decrease over time.

Final Word

Many still consider Bitcoin a highly volatile asset, meaning it may need to be suitable for use as a medium of exchange due to the risk involved in accepting payments with Bitcoin. However, the increasing liquidity in the market suggests that things could soon change, and merchants might eventually embrace Bitcoin as a payment method for goods and services if its price becomes less volatile over time.

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