Market MakingVenture CapitalAbout Us

What is Cryptocurrency Volatility?

May 11, 2023
/Table of contents


Marketing Batman

What comes to your mind when you think of volatility— is it uncertainty, fear, or like many traders, opportunity?

The key to successful trading in the cryptocurrency market is the ability to understand the mood of the market. Volatility is a statistical detail of the overall mood of a market, which allows you to determine the trend in the value of currencies and the strategy to employ for further investments.

The semantic concept of volatility originates from the Latin word 'volatilis', which means - 'fleeting', and 'rapid'. In the financial world, volatility is the statistics that measure the fluctuations in the value of an asset over a certain time period. Unlike stable assets such as government bonds, stocks, and gold, cryptocurrencies tend to make very wide jumps in prices in a relatively short period of time.

The first step in an investment strategy is risk assessment—understanding the price trend of assets. Volatility is a reflection of the level of risks of financial investments. Due to these facts, the market actively monitors cryptocurrency fluctuations and studies the reasons for their occurrence.

Volatility ahead (Source: istcock)

Causes of Volatility

The following factors have been recognized as the strongest influence on the volatility of a crypto asset’s exchange rate:

Lack Of Intrinsic Value Creates Volatility

Bitcoin and other cryptocurrencies are purely digital and therefore do not have any intrinsic value. They are also rarely linked to physical products and services. This makes it difficult to determine an exact value for a crypto asset. The effect of this is that there is no ‘right price’. Valuation is therefore mainly based on the opinion of experts and the news as well as buying and selling power- and these factors are very flexible.

New Market

The crypto market is still in its early phase. And this means there would be speculations, hesitancy, and distrust of the nascency of the crypto market.

Limited or no Regulation

Because the crypto market is still in its early stages, we see that many countries do not yet have regulations in place. This gives many parties free rein to manipulate the price. A common example of this is seen with the rapid 'pump and dump' of crypto assets. While this form of trading is outright fraud in other markets (even difficult to achieve), it is allowed and openly promoted in the cryptocurrency market. This naturally results in strong price fluctuations and thus a volatile market.

News and Media

Speculation drives the trend and the media spreads the news that attracts investors and sellers. It is not uncommon in the crypto market for reputable sources and notable figures to make comments on the strength and weaknesses of crypto coins. This increases volatility and sometimes leads to extreme swings. The hype in the media often causes chaos among the public who want to jump on the smallest indication to buy or sell a crypto asset. As a result, there is panic and fear in the market, leading to even greater volatility and liquidity.

Long-Term Investing Vs Short Term Investing Affects Volatility

Bitcoin and other crypto assets have not yet been recognized in many countries as authorized currencies or savings assets with interest benefits. Also, many financial advisors are yet to see cryptocurrency as an advisable wealth-building asset. As a result, there are few long-term investors in the crypto market. Short-term investors react more quickly to news, sharp price movements, and market fear and greed index. This naturally increases and affects volatility.

The Presence of Whales

Powerful traders can influence the price and movement of crypto assets through quick spot settlements i.e., one large market order can cause prices to rise or fall.

Compared to the rest of the competing financial world, the crypto market is still immature and very young, therefore these factors are able to significantly affect price movement as opposed to the traditional financial market.

Understanding Healthy Market Volatility

Crypto Vs Forex volatility (Source: Bytbitlearn)

Volatility is an essential feature of a good financial market (asset), and without it, it would be impossible for short and long-term investors to turn a profit. However, extreme volatility can lead to extreme losses, uncertainty, and chaos in the market that ultimately impact the market negatively.

Healthy market volatility helps assets to grow, and traders use the swing information to make a profit. Moreover, these changes create news and allow others to benefit from it.

According to the volatility index (VIX), healthy swings remain between 12% and 20% change in price. Any VIX number above 20 is considered extreme volatility and a volatility index less than 12 is considered a very low-volatility asset.

Why is Crypto Market Cap Important in Volatility?

The market capitalization and the prices of various crypto assets are highly dependent on each other. The market cap is the total amount of invested capital in the cryptocurrency and is calculated by multiplying the current price by the total supply of the currency.

The higher the market cap of the currency, the more difficult it is to influence the price of the crypto. This also reduces volatility. However, note that crypto projects where 30% or more of the crypto assets are concentrated in the hands of a few whales are easily manipulated irrespective of the market capitalization. Hence, the importance of adequate research before investing in crypto projects.

When looking for high volatility, you should pay attention to the rule - the smaller the capitalization of a coin, the greater the volatility in its price.

Can the Volatility Of the Crypto Market Be Reduced?

There are several approaches to reducing the extreme volatility of the crypto market. One such method is the introduction of stablecoins. These digital currencies, like tether (USDT) or the digital dollar (USDC), are pegged to stable assets like fiat currencies or commodities to keep their value constant. Even when the crypto market is very volatile, the price of such stable coins stays relatively the same.

Another method to improve liquidity in crypto markets is by making trading platforms and exchanges work more closely together and getting institutional investors more involved in the market. The expansion of crypto derivatives markets, such as futures and options, has also helped reduce volatility. These markets allow market participants to hedge against price changes and this promotes price stability.

Stronger and more secure market infrastructure, such as trading platforms, exchanges, and wallets, can also help reduce volatility by increasing investor confidence in the crypto market. In addition, it is important to create a clear regulatory framework for cryptocurrencies in order to increase confidence in the market. This improved market infrastructure will facilitate the entry of institutional investors who have longer-term investment horizons and can help stabilize the market.

Summing Up

The volatility of cryptocurrencies is one of the biggest challenges to overcome in order to establish them as a reliable means of payment. It is obvious that crypto volatility will decrease and prices will become more stable when the above factors change and the crypto market matures. In general, it is expected that a more stable exchange rate will lead to more interest, especially from larger parties. As a result, prices are also expected to rise steadily in the long term.