Why are bitcoin and other cryptocurrencies so volatile right now?

If you own bitcoin, the past 10 days will have been brutal. On 9 June, it was still trading above $30,000. This weekend it was above $20,000 in the early hours of Saturday morning London time, but plunged to below $18,000 for a few minutes on Saturday evening. Since then it seems to have made a partial recovery.

So what have we learnt? When you get these extreme movements in any asset, the best thing to do is to think dispassionately about where there has been new information, or at least information that helps clarify earlier judgements. I suggest that we can identify five main lessons from this bumpy period, and one area of total uncertainty that will persist for a couple of years at least.

Lesson one stems from the extreme volatility of the past few days. It is that the market for bitcoin is very narrow, given its still-massive market capitalisation. At around $19,500, the market capitalisation of bitcoin is $370bn. By comparison, that makes it quite a lot more than, for example, the oil giant Shell, worth around $200bn.

With an asset of that size, you would expect there to be a lot of short-term traders, seeking to buy on the dips and sell on the rises. Their actions help to smooth out the market price on a minute-by-minute basis, so that you only get really big movements in prices when new information comes along.

That isn’t happening with bitcoin. It is traded 24 hours, seven days a week, so you would expect periods where the market is thin. The big lurches in price do seem to happen in the middle of the night European and US time. But even allowing for that, it is clear that it is an illiquid security. Try to sell or buy a large amount, and you move the price against you. And if this is true for bitcoin, it is even more true of the other cryptocurrencies, which are even more volatile.

Lesson two follows from that. It is that cryptocurrencies are not useful as a means of transaction. You may want to hold them as an asset. That is a separate decision. But they have only limited use if you want to buy something. It is hard to pin this down, but they probably are not much use for money laundering.

There are two countries in the world, El Salvador and the Central African Republic, where bitcoin is legal tender. But as we reported a week ago, El Salvador’s holdings are down 50 per cent in value, and its use in the shops appears limited.

Nevertheless, and this is lesson three, there is considerable commitment to crypto that is still very evident. For example, Mike Novogratz, the founder and chief executive officer of Galaxy Digital Holdings Ltd, predicts that it is going to take a while for bitcoin and ethereum to return to a bullish phase. “The moment the Fed flinches, and says oh we’ve raised enough we can’t do it anymore, I think you’ll see lots of traditional macro funds, who’ve had a great year, buy bitcoin. We’ll add to our position at that point,” he told Bloomberg.

That leads to lesson four – the key issue will be the Federal Reserve’s interest rate policy. I think we all knew that this would be absolutely crucial, but we learnt last week with its 0.75 per cent increase in rates that it was for real in its efforts to crush inflation, even if this were to lead to a recession in America. And, as we have seen, the move to tighter monetary policy hits the more speculative investment categories, such as crypto, the hardest.

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And lesson five? It is that the experts really know nothing. Look around now and you have PWC reporting that a majority of crypto fund managers think bitcoin will go to $100,000 by the end of the year. You have Bill Gates saying that he won’t touch crypto at all. There is Elon Musk saying that his company SpaceX will take dogecoin payments, a statement that boosted its price by 10 per cent. This is chaos.

The normal metrics for valuing this type of asset – price to book, price earnings ratio, projected dividend stream and so on – do not apply. We know we are flying blind.

And so to the uncertainty. What is the long-term future of bitcoin and the rest of the pack? Here, I suggest that it will take a couple of years of “normal” interest rates – interest rates that match or are a little above inflation – before we can make a judgement. Bitcoin was officially launched in 2009, so its entire life has been during a period of abnormally cheap money. There has never been a period of such low interest rates before. Never. We have just begun the march back to normality, with the Fed projecting that rates will be 3.2 per cent to 3.4 per cent by the end of this year.

However, it will take two or three years before the world adjusts to the end of free money. Then, and only then, will we know whether crypto has a future.