Why Are Cryptocurrencies So Volatile?

If you’re in the cryptocurrency industry or are looking to invest in the market, one of the most common nuggets of advice you’ll receive is – “the market is highly volatile.” That’s because, since its inception, Bitcoin, and indeed cryptocurrency, embodies the term “roller coaster ride,” with its wild fluctuations. It has faced stupendous lows and spectacular highs over the course of a decade and a bit.

Then again, why is crypto so volatile? What are the factors that govern its prices, and will it ever reach a point of stability? We’ll explore these pointers in the article, and hopefully, you’ll receive the answers you seek.

Cryptocurrency Volatility – What Triggers The Same?

To understand why cryptocurrency is so volatile, you must understand the very nature of its volatility. 

Bitcoin was worth about $20,000 in December 2020. In January, it hit $40,000 (roughly Rs. 29.70 lakh). In April, it hit a new high of $65,000 (roughly Rs 48.27 lakh). This was followed by a June crash below $30,000 (approximately Rs 22.28 lakh). Around July 20, the coin surged to $45,000 (roughly Rs 33.42 lakh). With such astonishing volatility occurring, there are a few factors that contribute to it.

1. It’s still an emerging market:

The scale of the cryptocurrency industry is still insignificant in comparison to fiat currencies and gold, despite the extensive media coverage that has been given to cryptocurrencies over the years. Even at its zenith, the bitcoin market accounted for about $2 trillion in total. 

When compared to the whole worth of the gold market, which is $7.9 trillion, and the estimated value of the stock market in the United States, which is $28 trillion, it still has some way to go to reach that value.

Because of the tinier scale of the market, lesser influences might have a more significant impact on the price of the commodity. If a single group of investors chose to sell $500 million worth of gold, the price of gold would scarcely move as a result of their decision. If anything similar occurred to Bitcoin, it would be sufficient to disrupt the entire market and cause the price to plummet.

However, the reality that the cryptocurrency industry is still in its early stages means that there are several possibilities to enter the market with a novel and intriguing concept. 

2. Cryptocurrencies are completely digital in nature:


The vast majority of cryptocurrencies, such as Bitcoin, are entirely digital assets that are not backed by anything tangible, such as money or a commodity. This implies that the price of their products is totally determined by the principles of supply and demand.

Because the supply of certain cryptocurrencies, such as Bitcoin, is predetermined and predictable, the price of Bitcoin is determined by how many individuals are interested in purchasing Bitcoin at any one time.

There is no tangible object that can be used to support the worth of the major cryptocurrencies, and there are no governments that can mandate its usage as a form of payment. This indicates that their worth is totally dependent on faith. If individuals no longer feel that the price of Bitcoin will remain or will continue to grow, they will most likely sell their Bitcoin.

Thus, a cycle is formed, with the price rapidly falling as a result of other people selling their goods as well, further lowering the price. The inverse can also occur, causing prices to rise sharply and resulting in the formation of overinflated price bubbles. However, the price of crypto has been steadily rising despite the fluctuations and is a good indicator for potential investors.

3. Security breaches:

As a result of the bitcoin community exposing security flaws in an effort to generate fixes, the price of crypto might become erratic. This approach to security, ironically, yields excellent results, as seen by the numerous beneficial open-source software efforts, like Linux, that have sprung out as a result of it. Bitcoin and crypto developers must disclose security problems to the world community to build effective solutions for the cryptocurrency.

It is the same underlying principle that underpins both crypto and open source software development: that users should have access to the source code and should be encouraged to do so.

By adopting this approach, the community assumes accountability for raising issues regarding software design, just as the community assumes accountability for reaching an agreement on improvements to the underlying source code as well. 

Earlier in 2017, Youbit, a South Korean cryptocurrency trading firm, incurred losses of up to 17%, prompting the company to declare bankruptcy. This instils dread in the minds of investors, prompting them to sell their investments in order to avoid such incidents in the future.

 

4. The technology is still in its early stages:

Blockchain and other competing crypto technologies are still in their infancy and are only beginning to see widespread use. 

Given that it has only been a decade since the concept of cryptography-based decentralised currencies was first revealed in the Bitcoin whitepaper, it will be some time before the market reaches maturity. Despite this, a large number of businesses like Microsoft, PayPal, Etsy, and more have already embraced blockchain technology and are proactively utilising it for promotional and advertising purposes.

As long as technological challenges, like the blockchain scalability issue, remain unsolved in the period that many anticipate, they exert downward pressure on cryptocurrency values.

5. Market speculation:

Speculation is one of the most important factors contributing to the volatility of the bitcoin market. This includes investors placing bets on whether the price of various cryptocurrencies will rise or fall by purchasing and selling different cryptocurrencies. According to the cryptocurrency market’s inherent volatility, it is this that attracts speculative traders seeking to earn huge amounts of money by accurately predicting price fluctuations.

If you can predict when the bitcoin price or XRP will skyrocket and purchase just before it happens, you can make a profit in the cryptocurrency market. Similarly, if you are able to short sell a cryptocurrency just before it falls, you may make a profit as well.

Generally speaking, short selling is a straightforward concept: a trader borrows a stock, sells it and then purchases the stock back to pay back the lender. Short sellers are those who wager that the stock they are selling will decline in value. 

Many investors are always attempting to predict the ups and downs of the bitcoin market, which is extremely difficult. These speculative investments worsen the already turbulent market by causing even greater volatility, and detractors add fuel to it by posing questions like, “Why the crypto market is down?”

6. Bad news hurts its value by a lot:

Geopolitical events and assertions by government authorities that bitcoin is likely to be controlled are examples of news events that cause concern among bitcoin users. There were a number of unscrupulous actors among Bitcoin’s early users, resulting in headline-grabbing news articles that fanned investor fears.

The collapse of Mt. Gox in early 2014, as well as the insolvency of the South Korean cryptocurrency exchange Yapian Youbit, have all made headlines during the course of bitcoin’s roughly 10-year existence. Other news items that have taken investors by surprise include the high-profile usage of bitcoin in drug sales via the Silk Road bazaar, which was shut down by the FBI in October 2013 after being exposed by the media. 

All of these instances, as well as the resulting public, fear whenever news about crypto going down flashes, cause the value of bitcoins to plummet in comparison to fiat currencies. A short while after these news events, however, bitcoin-friendly investors interpreted such occurrences as proof that the market was maturing, resulting in a significant increase in the value of bitcoins relative to the dollar. 

What does the future hold?

One thing that’s for sure is that cryptocurrency has taken the world by storm. Governments all around the world have had to make moves to either ban it or begin regulating it. In fact, on 8th September 2021, El Salvador even became the first country to make Bitcoin legal tender, in an experiment that the world will be watching with great interest.

The different factors that govern the volatility of cryptocurrencies might change in the future as the market develops, and soon we might live in a world where it is legal tender. Investors in the crypto market are positive and hope for a regulated future, where it is used in tandem with other currency forms. Let’s wait and watch!

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Published on: 12/21/21, 4:15 PM