Volatility is a measure of how the price of a cryptocurrency moves over time. The more volatile the wallet is the riskier it is to invest in it and the more potential it has to offer. The volatility affects an investor’s career a lot – it may ruin you completely or make you tremendously richer.
As a newer asset class that’s only a little more than a decade old, crypto is considered to be more volatile than stocks. The movements are typically going up and down over shorter periods of time. So why is cryptocurrency so volatile? We will find out later in the article.
How is volatility measured?
When we talk about measuring Bitcoin volatility, it’s usually referring to “historical volatility,” a number we get from studying prices over a specific time period, often something around a month. “Implied volatility” is the term we use to describe the prediction of future movements.
We can qualify how volatile is Bitcoin in a couple ways: The first method is a beta, which measures how volatile one asset is in relation to a broader market.
The other method is to compute an asset’s standard deviation. It is a measure of how the price diverged from its historical average.
Why is volatility important to understand?
Volatility is a basic factor helping investors to assess the risks. Investors take higher risks if they believe in a big chance of reward and that it is worth losing some part of their investment. It is advised to invest in several assets to reduce risks.
The trading volume of Bitcoin and institutional participation seem to reduce volatility of it, while cryptocurrencies with lower trading volume and newer types of assets are typically more volatile. When experimenting with investing in it you better expect to lose a part of your funds and invest only what you can afford to lose.
Why is crypto so volatile?
1. Lack of Regulation
Bitcoin and other cryptocurrencies are not controlled by any legal entity. This is what makes crypto anonymous. Anonymity either repels or attracts investors to buy crypto which affects the supply of it. As a result of blockchains being distributed between different systems all over the world it is hard to manage all of them. This way regulatory measures imposed often lead to high crypto volatility.
2. The Sentiment Factor
There is no intrinsic value to Bitcoin that is why it is not widely accepted by masses, and by investing in it people hope it will gain acceptance in the near future.
The moves of volatility depend on mechanisms that will soon be discovered as crypto gains in popularity. Until then, investors speculate based on opinions.
3. Limited Supply Of Bitcoin
Talking about why Bitcoin is so volatile, we should also talk about miners who use their computing power to validate transactions through the decentralized networks are gaining rewards. The rewards are newly minted Bitcoins that tend to be halved over time so the supply of it is completely inelastic. The route to accurate price discovery is frequently paved with seismic price fluctuations.
4. Bitcoin Speculation
The nature of cryptocurrency attracts speculative investors who want to gain money off price swings. As no physical asset backs up its value, the price of it is dependent on faith solely. This is one of the main reasons why crypto is so volatile. The price will get lower if the faith of followers will be lost and increase if Bitcoin will gain more popularity.
5. The Media and Bitcoin
Influencers play a big role in forming the price of Bitcoin. Speculators often follow trending headlines to predict the price of which cryptocurrency will soon skyrocket or wreck the market.
6. The Bitcoin Investor Profiles
It is easy to start investing in crypto as anyone with a couple of dollars in their pocket is able to start trading. You can invest even with little knowledge and that is why the crypto market is so susceptible to hype and manipulations.
So what affects volatility?
Why does cryptocurrency fluctuate? Here is quite a bunch of factors:
1. The Market
The price of assets first of all depends on supply and demand at the market. The relationships between these two determine all changes.
2. Bad News
Industry-related and global events have its impact as well. Values go up as the news is good and go down if news is bad. Same do macro factors such as interest rates, inflation, and other monetary policies.
3. Whales
Whales are the people who hold huge chunks of crypto. By being stagnant, these investors may make the market volatile as it affects liquidity.
4. Perceived value
When crypto investors perceive values as lower they tend to go down for real.
5. Cybersecurity concerns
As cryptocurrencies belong to decentralized technology, the public is needed to solve an issue.
6. Tax treatment and regulations
Crypto gets taxed in some countries so traders have to record the value of crypto at the time of each transaction. The other nuance is that it may be necessary also to pay capital gain taxes. The negative impact of regulations often scares people away.
7. Innovation factor
Being a relatively new thing, crypto is not trusted by many.
8. No central authority
There is no authority like a bank to stabilize the prices.
Are there ways to reduce crypto volatility?
For many the volatility is a part of appeal as it creates the possibility for high returns. Unlike those who use volatility to profit, there are less risk-tolerant investors. For them there are strategies that can be used to limit the downside impact of volatility. What is more, there are special currencies that are designed to have low volatility – stablecoins. These coins have their prices pegged to reserve assets like fiat or gold.
