Volatility is defined as the variation of an asset’s price over time. Bitcoin (and cryptocurrency in general) have been characterised by high volatility.
If an asset is more volatile, changes in price are more severe and frequent over a fixed time period as compared to a less volatile asset. Volatile assets are more difficult to hedge against but provide more opportunities for traders and investors who want to trade the asset’s fluctuations.
The Bitcoin Volatility Index tracks how much the price of bitcoin varies over time, specifically over a 30-day period and a 60-day period. The volatility of bitcoin has fallen over time as the ecosystem has matured, as displayed by the chart below.
It is clear from the chart that volatility is cyclical. Periods of high volatility are followed by periods of low volatility. The 30-day and 60-day estimates are both close to 3% while early in Bitcoin’s history the figure was much higher reaching 15% in 2011. Even though the variation in bitcoin’s price has fallen significantly, the cryptocurrency is still very volatile compared to gold and traditional currencies.
Bitcoin's volatility is mainly a result of the small market size and low liquidity. The volatility is also down to the fact that the supply is highly inelastic, meaning that supply does not respond that much to a change in price. Hence, Bitcoin's price fluctuations are mainly based on demand which can vary significantly over short time periods.
Trading strategies such as the Bollinger Bands use the cyclical nature of volatility to provide high probability trade setups.