Whether or not you invest in cryptos, you must have heard about the big swings in the crypto markets. Someday you might listen to Bitcoin surging 40% in a day. Or, more recently, you might have heard about cryptocurrencies like LUNA crashing 95% in a week. This insane crypto volatility is the biggest driver of the nascent cryptocurrency market. It’s what the risk takers love, and conservative investors fear the most. But why is crypto so volatile? What causes the volatility in cryptocurrency? And most importantly, how can one navigate through it as an investor?
In this blog, we will help you answer all these questions.
What Causes the Volatility in Cryptocurrencies?
Cryptocurrency is still a new and developing market, so there is ‘uncertainty’ that can drive market volatility. For instance, when RBI (Reserve Bank of India) suggested banning all cryptocurrencies in 2018. It scared all the cryptocurrency investors in India, leading them to dump their cryptos (even at losses). This incident resulted in high crypto volatility in the markets and exchanges, contributing to a sharp price decline.
Again, when China banned all crypto mining-related activities in 2021, there was a significant drop in cryptocurrency prices.
Apart from uncertainty, there are broadly two categories that affect the volatility of cryptocurrencies:
- Demand and Supply
- The Underlying Technology of a Cryptocurrency
Let’s understand in detail how both of these factors affect crypto volatility.
Factors Affecting the Price Fluctuations in Cryptocurrencies
Demand and supply are one of the biggest factors causing volatility in the cryptocurrency market. And due to the 24/7 trading option, it is more vulnerable to external shocks at even ungodly hours.
Demand and supply
Here are the factors that impact the demand and supply of a cryptocurrency and thus affect its volatility.
1. Scarcity
Scarcity of a crypto is one of the reasons that could impact its volatility. Take Bitcoin, for example, it has a limited supply of 21 Million coins.
If all Bitcoins are mined, and there is any spike in its demand; its price will move up because there is no new supply coming. Any crypto with a scarce supply will experience major volatility, if there is a sudden surge or decline in its demand.
2. Whales
The early adopters of cryptocurrencies who hold massive volumes of coins are called crypto whales. Because they hold massive supply of any one or multiple cryptocurrencies, they are in a position to move the market.
In other words, they can both cause and absorb volatility in cryptocurrency markets. Imagine a coin having normal fluctuations and trading. But then a crypto whale decides to go on and dump 10,000 coins into the market. Well, it will be time to pray to god because the price will surely collapse after this move.
A crypto whale dumping a coin might signal to other investors that he or she has lost confidence in the cryptocurrency. This might also trigger them to sell their stake. Therefore, plunging the price even more.
Hence, crypto whales can be powerful movers of the market, causing major volatility in cryptocurrency with their moves and even words.
The underlying technology of a cryptocurrency
1. Utility
The utility of blockchain is the value that any cryptocurrency provides. Just like we do a fundamental analysis of underlying companies while investing in stocks, it is important to do the same for cryptocurrencies. You can look for the use case of a crypto and the problem it is trying to solve from its whitepaper.
For example, Bitcoin has only one use case. It was created to act as a digital currency and is now being used as a store of value. On the other hand, Ethereum has multiple use cases, and various apps are being built on it using smart contracts.
These use cases help us understand how widely the technology of a crypto could be adopted and what its scope is in the future. If a blockchain has multiple use cases and a great adoption, it can be said to be a fundamentally strong crypto.
However, changes to utility, proof of working, and adoption may further influence the value of a crypto.
2. Security breaches
At its core, blockchain technology is a software. If there is a security breach or an algorithm that is compromised, it can put the integrity of the entire system at risk. And this is bad news, as security breaches can be harmful to the apps and utilities that run on that blockchain. It may also open the network up to vulnerabilities, such as theft of coins or tokens.
Naturally, this will cause major ripples in the crypto market, leading to panic among the community and investors and thus influencing the volatility of the market.
What Does the Future Hold for Crypto Investors?
It is an undisputed fact that cryptocurrency will be a big part of the future. With the Web 3.0 revolution just around the corner, there is a demand for more global and decentralized technologies. And volatility is no reason to be ignorant of it, the crypto market is a developing market, and any developing market is volatile.
Also, volatility isn’t a bad thing always. It’s just that as an investor, you should know how to navigate through this volatility to reap the benefits of this growing and booming market. So instead of asking, “why is crypto so volatile?” start asking, “how to navigate this volatility?”. The change in perspective will make all the difference.
Don’t worry! We are not here to just give you a philosophical bend on what question to ask. We’re here to answer them too.
As a crypto investor, you cannot avoid volatility. But you can definitely dodge it by following the below tips –
- Study the market and the cryptos thoroughly before investing in them.
- DO NOT invest in any cryptocurrency just because someone told you to do so. There are a lot of self-proclaimed gurus out there. Don’t trust them. Don’t even blindly follow your friends and their portfolio. Always DYOR (Do Your Own Research) when it comes to investments.
- If you do not have the time to understand a blockchain project and evaluate it, there is no need to panic. Try crypto baskets!
Crypto baskets are a type of mutual fund but for cryptos. It is a basket of carefully assessed cryptocurrencies curated by experts for better risk-adjusted returns. These crypto baskets are based on a particular theme of the crypto ecosystem, for instance, Metaverse, NFTs, etc. You can simply choose a Coin Set depending on the theme you believe in, and voila!
You can also invest in Coin Sets through SIP or Recurring Investments. It can help in averaging the volatility in the cryptocurrency market.
So, little-crypto-riding-hoods, stop worrying about why crypto is so volatile and start your crypto investment journey embracing the volatility like a pro.
FAQs
1. Will cryptocurrency always be volatile?
Depends. Volatility is a function of a lot of factors, including but not limited to market sentiments, the age of the asset, fundamentals, etc. Hence it is very difficult to determine if cryptocurrency will always be volatile.
2. Is crypto more volatile than stocks?
Yes, crypto is more volatile than stocks. This is because cryptocurrency is a new class of asset and all asset classes take some time before stabilizing. The lack of government regulation and a FUD (Fear, Uncertainty, and Doubt) just adds fuel to the fire.
3. Why is Ethereum so volatile?
Ethereum, or any crypto asset, is volatile because of the newness of the asset class. Also, the regulatory uncertainty around crypto has a role to play. But if compared with other smaller cryptos, Ethereum is relatively stable.
4. Where does cryptocurrency get its value from?
Cryptocurrencies gain their value primarily from demand and supply. Additionally, their fundamentals and the problem they are trying to solve also helps them maintain their demand and thus influence their value too. However, at times some people might just drive the value of a crypto through some pump-and-dump schemes to gain.
