Bitesize: How volatile is Bitcoin?

Giulio Malberti and Thom Adcock

In late 2017, Bitcoin was in the spotlight for its extraordinary return. But how volatile is it?

To consider Bitcoin volatility, we look at 10-day returns (capital standards typically estimate market risk over a 10-day period) since 19 July 2010, when Bloomberg’s Bitcoin data start. We compare Bitcoin with assets in three categories – currency pairs, commodities and equities – and for each we have picked one low-volatility asset and one more volatile asset. For currency pairs and commodities, we chose the most and least volatile ones (in terms of standard deviation of 10-day returns) out of the most liquid in each category. And we chose the most and least volatile FTSE 100 equities (again, in terms of standard deviation of 10-day returns).

For stable assets we expect a peaked distribution with short tails, as returns cluster near 0%. Figure 1 shows that Bitcoin has been more volatile than any other asset in our sample.

Figure 1

But people are often interested in the downside risk of assets. We therefore consider how Bitcoin’s Value at Risk (VaR) compares to other assets. VaR is the maximum loss over a given time interval under normal market conditions at a given confidence interval (eg 99%). A 10-day 99% VaR of -10% tells you that 99% of the time your 10-day return on the asset would be no worse than a 10% loss.

Figure 2 shows Bitcoin’s VaR is high, but the VaR of the other most liquid crypto-assets is higher. TRON’s VaR to date (-84%) is almost twice Bitcoin’s (-44%).

Figure 2

Giulio Malberti and Thom Adcock work in the Bank’s Banking Policy Division.

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A balancing act: the case for macroprudential margin requirements

Cian O’Neill and Nicholas Vause.

Certain policy actions require a high level of precision to be successful. In a recent paper, we find that using margins on derivative trades as a macroprudential tool would require such precision. Such a policy could force derivative users to hold more liquid assets. This would help them to meet larger margin calls and avoid fire-selling their derivatives, which could affect other market participants by moving prices. We find that perfect calibration of such a policy would completely eliminate this fire-sale externality and achieve the best possible outcome, while simple rules are almost as effective. However, calibration errors in any rule could amplify fire-sales and leave the financial system worse off than if there had been no policy at all.

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Reflections on the Bank’s History

David Kynaston

Last May, the Bank organised an economic history workshop at the St Clere Estate, home of former governor Montagu Norman. In this guest post, one of the speakers David Kynaston, visiting Professor at Kingston University, reflects on more than three centuries of Bank history…

It was a huge honour to be asked by Mervyn King to write a history of the Bank. The eventual book, Till Time’s Last Sand, was published last autumn. It covers 1694 to 2013 and is based heavily on the Bank’s own archive. Fitting more than 300 years of history into a single volume was a difficult task, and condensing that into a short blog post is harder still. Here I will try to bring out a handful of key lessons from my research into the Bank’s history that might be useful for the policymakers, economists and other interested observers of today – and their successors…

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Repo Market Functioning: The Role of Capital Regulation

Antonis Kotidis and Neeltje van Horen

The leverage ratio requires banks to hold capital in proportion to the overall size of their balance sheet. As opposed to the capital ratio, risk-weights are irrelevant to its calculation. The leverage ratio therefore makes it relatively more costly for banks to engage in low margin activities. One such activity – which is crucial to the transmission of monetary policy and financial stability – is repo.  This column shows that a tightening of the leverage ratio resulting from a change in reporting requirements incentivised UK dealers to reduce their repo activity, especially affecting small banks and non-bank financial institutions. The UK gilt repo market, however, showed resilience with foreign, non-constrained dealers quickly stepping in.

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The Spanish Connection – Consequences of a macroprudential regulation in Spain on Mexico

Jagdish Tripathy

Does macroprudential regulation spillover to foreign financial systems through inter-bank linkages? This question has received a lot of attention in recent years given the discord between the international nature of the global financial system and its regulation and supervision by national jurisdictions (e.g. this article). For example, subsidiaries of Spanish banks issue almost half of all credit issued by commercial banks in Mexico. These subsidiaries are also fully owned by their parent banks headquartered in Spain. Therefore, it is quite natural to ask whether macroprudential regulations in Spain can have unintended consequences on the Mexican financial system and the Mexican economy in general. While Mexican subsidiaries of Spanish banks are de-jure ring-fenced from regulations in Spain, does this hold de-facto?

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Who’s driving consumer credit growth?

Ben Guttman-Kenney, Liam Kirwin, Sagar Shah

Consumer credit growth has raised concern in some quarters. This type of borrowing – which covers mainstream products such as credit cards, motor finance, personal loans and less mainstream ones such as rent-to-own agreements – has been growing at a rapid 10% a year. What’s been driving this credit growth, and how worried should policymakers be?

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Will Pay Clawback Tame Damaging Risk-Taking In The City?

Misa Tanaka and John Thanassoulis

In the 2007-8 global financial crisis, a number of banks were bailed out by taxpayers while their most senior employees were paid extraordinary bonuses up to that point (E.g. here, here and here). The resulting public outcry led to new regulations allowing clawback of bonuses earned on the back of decisions that subsequently damage their banks and the wider economy. But will these rules work? Our theoretical research shows that sophisticated banks can game clawback regulations by altering pay contracts so as to incentivise bankers to take risks that benefit shareholders but that are excessive for society. The entire pay package matters, and so, understanding how it shapes risk-taking incentives is as important as monitoring compliance with clawback rules.

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The decline of solvency contagion risk

Marco Bardoscia, Paolo Barucca, Adam Brinley Codd and John Hill

The failure of Lehman Brothers on 15 September 2008 sent shockwaves around the world.  But the losses at Lehman Brothers were only the start of the problem.  The price of their bonds halved, almost overnight.  Other institutions that held Lehman’s debt faced huge losses, and markets feared that those losses could trigger further failures. The good news is that our latest research suggests that risks within the UK banking system from one such contagion channel, “solvency contagion”, have declined sharply since 2008. We have developed a new model which quantifies risk from this channel, and helps us understand why it has fallen.  Regulators are using the model to monitor this particular source of risk as part of the Bank’s annual concurrent stress test exercise.

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Reducing counterparty credit risk in uncleared markets – but what are the costs?

Darren Massey

When you rent a house, the landlord – your counterparty – will take a security deposit as prepayment to cover potential costs such as unpaid rent or bills. New regulations introduced in major jurisdictions will require major participants in uncleared over-the-counter derivatives (OTCDs) markets to uniformly exchange initial margin – a more complicated version of a security deposit. Much like a rental deposit, OTCD parties must agree the deposit amount, who should hold the funds, and crucially, when a claim can be made. And just like the rental deposit, the protection provided brings new challenges and risks. This blog outlines some of these risks in the OTCD market, and as the framework is implemented, suggests that firms and regulators should consider these risks.

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Insurance companies: amplifiers or the white knights of financial markets?

Graeme Douglas, Nicholas Vause and Joseph Noss

Risky asset prices plummeted following the collapse of Lehman Brothers in 2008. Whilst driven partly by deteriorations in fundamental news, these falls were amplified by ‘flighty’ investors that sold at the first signs of trouble. Conventional wisdom dictates that life insurers, with their long-term investment horizons, are better placed than most to ‘lean against the wind’ by looking through short-term fluctuations in asset prices. They could thereby stabilise prices when others are selling. But the structure of regulations can greatly influence insurers’ investment incentives. Using our model of insurers’ asset allocations, we find that new ‘Solvency II’ regulations reduce UK life insurers’ willingness to act as the white knights of financial markets, particularly in the face of falling interest rates.

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