Why is Crypto so Volatile

Bitcoin and other cryptocurrencies are notorious for their extreme volatility, which is caused by a number of causes. Not only is bitcoin the financial sector that is developing at the fastest rate right now—its history is just over ten years old—but it is also an extremely volatile one.

The incredibly volatile circumstances in this particular market have a big effect on software entrepreneurs, institutional investors, and individual traders—all of whom gauge success in terms of dollars.

It takes a great deal of understanding of the dynamics of this volatility for investors and developers to manage the dangers that come with price swings in the recently established asset class and crypto business. This piece aims to address the common inquiry of readers: what causes cryptocurrency’s extreme volatility?

Volatility in Crypto Markets

The measurement of an asset’s price changes over time is called volatility. An asset is considered highly volatile if its price varies a lot and experiences sharp ups and downs. When the word “volatility” is used in casual conversations, it typically refers to “historical volatility,” or historical price movement that has been seen over a specific period of time. “Implied volatility” is the forecast of the anticipated price changes (price volatility) in the future.

High-volatile assets have a higher potential for both profit and loss, making them often regarded as riskier investments. Because of their extraordinarily quick price increases and decreases over time, cryptocurrencies are regarded as an exceptionally volatile asset class.

For instance, the price of Bitcoin increased by more than 110%, from $18,000 to $38,200, just between December 2020 and January 2021. In a similar vein, the whole market value of cryptocurrencies fell by almost 60% between April 2022 and June 2022, shedding an incredible $1.27 trillion in less than 90 days.

Both experienced traders and those who are new to the field of digital assets are interested in this volatility, which has made it necessary to comprehend the causes of this price instability.

Factors Contributing to Crypto Volatility

The core characteristics of the cryptocurrency market that increase its natural volatility are as follows.

Decentralization

Decentralization, one of the fundamental tenets of blockchain technology, is one of the main causes of the severe market volatility. Blockchain platforms and cryptocurrency initiatives are not held by a single person or organization, in contrast to conventional corporate enterprises or traditional fiat currencies. Rather, the user community itself owns and manages the entire project.

Decentralized governance has certain disadvantages in addition to its many advantages, which include security, transparency, and a trustless environment. The lack of a central authority frequently causes uncertainty about the future of the cryptocurrency initiative. The roadmap and strategy plan for upcoming developments are not established right once, in contrast to centralized enterprises.

For instance, when Ethereum, the second-most popular cryptocurrency, was first introduced, it was not intended for it to transition to a proof-of-stake model in its latter year. Instead, this choice was made a few years after the coin’s release to the general public. Another well-known cryptocurrency project, Bitcoin Cash, was produced by a hard fork that divided the original Bitcoin blockchain.

Following the proposal of new platform rules by certain community members, there was a hard fork. As a result, the decentralized system of governance frequently causes uncertainty and unpredictability in the development space, which in turn causes volatile cryptocurrency prices.

Lack of Regularity Framework

In all financial markets, the regulatory environment has a big impact on everything from price volatility to market mood. Since its inception, the cryptocurrency industry has been hindered by the absence of a comprehensive regulatory structure set by national authorities. Therefore, the price of Bitcoin and the cryptocurrency market as a whole are greatly impacted by any declarations, acts, or even rumors of upcoming regulations on initial coin offers (ICOs) and the legitimacy of the exchanges from any government in the world.

Moreover, increased market volatility is partly a result of the absence of international agreement on cryptocurrency regulation. Some countries, such as El Salvador, are adopting blockchain technology and this new asset class. However, some nations, like Saudi Arabia and China, are very severe and have outright banned cryptocurrencies because they are worried about money laundering and possible threats to the stability of the financial system.

In an environment where speculation and uncertainty are rampant, the mere prospect of a ban may trigger panic selling and sharp price drops. On the other hand, a single affirmation that the cryptocurrency market will continue to be accessible and lawful to the general public might stimulate the market and lead to positive price fluctuations.

Absence of Fundamental Valuation Metrics

Another important aspect contributing to the volatility of cryptocurrencies is the absence of conventional valuation metrics that are common in established financial markets. Cryptocurrencies lack the readily quantifiable signs that many investors use to determine an asset’s inherent worth, in contrast to stocks and bonds.

The most often used valuation indicators are discounted cash flow models, price-to-book ratios, and price-to-earnings ratios. Since cryptocurrencies are primarily relatively new projects that have only been around for a few years, these criteria cannot be applied to them as they are based on known financial concepts and historical market data.

Furthermore, cryptocurrency projects don’t fit well into the conventional frameworks for valuation that are applied to equities, bonds, and other conventional markets. For instance, Ether, the native cryptocurrency token of the Ethereum blockchain, was first offered as a security because the firm wanted to use the proceeds from sales to support development.

But as the blockchain technology was introduced, its usefulness expanded to include both a money and a commodity. With regard to Bitcoin, the project was made available as a peer-to-peer transaction medium. However, as time has gone on, cryptocurrency investors have come to view it as a store of value.

Market Manipulation

All financial classes have problems with market manipulation, and the cryptocurrency industry is no different. However, this investing industry is extremely vulnerable to many types of market manipulation, most notably pump and dump scams and whale manipulation, because of the previously mentioned decentralized and poorly regulated structure of these assets.

One of the most notorious types of cryptocurrency manipulation in recent memory is pump and dump. Here, con artists and manipulators use incorrect information and fake news to artificially increase the value of a coin. As a result, retail investors become FOMO-prone and follow the trend by investing their money. The manipulators sell their holdings as soon as the token’s price reaches its peak, which causes the cryptocurrency to dump.

When it comes to cryptocurrency, people or organizations that own large amounts of the asset—known as “crypto whales”—manipulate the price to their advantage. They are able to carry out sizable transactions that directly impact the asset’s supply or demand. In an effort to chase the dollar, these trades cause smaller traders to panic and sell or purchase, which further fuels unforeseen price volatility.

Conclusion

From the perspective of the investor, the bitcoin industry’s high volatility is cause for grave concern. While investors may profit from short-term volatility by seeing a rapid increase in the value of their assets, the cryptocurrency industry must find a long-term solution to reduce volatility before it can become a recognized industry similar to stocks and bonds.

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