Walking on thin ice – Why is the crypto market so volatile?

A lot of things have changed since the inception of the cryptocurrency industry. After the launch of Bitcoin in 2009, we’ve seen numerous other crypto projects emerge on the market, some more successful than others but none capable to outperform Satoshi Nakamoto’s brainchild. The Bitcoin and Ethereum price experienced massive spikes and falls, leading to considerable gains and losses; the population become more educated on digital currencies and the technology that powers them; businesses and organizations started to accept crypto as a payment method; governments took note of this intriguing and tricky assets class and set out plans to regulate it. All these changes and developments have moved cryptocurrency closer to mainstream adoption. 

But if there’s one thing that has remained the same throughout all these years, it is volatility. Everyone knows that movements in the crypto market are erratic and difficult to predict. Prices can rise one day and plummet the next without prior warning. One can argue that all markets present a certain degree of volatility, and that is perfectly true. Traditional assets like stocks, bonds, and fiat are no strangers to price swings, but their volatility is generally moderate and it can be traced back to certain market conditions. In contrast, digital assets have a different kind of volatility with much sharper spikes and crashes that occur more frequently and it’s more difficult to pinpoint a precise cause. 

That being said, crypto volatility is not an unexplainable phenomenon either. Many of the factors that influence mainstream markets like economic conditions, government actions, news and social media hype also have an effect on digital currencies. But there are also elements that are unique to crypto and come to exacerbate their volatility, and those are the aspects that we’re going to focus on in this article. 

Newness

It’s true that we know a lot more about crypto today than we did ten years ago. And yet, there are still so many things that people don’t understand about digital assets and so much potential to uncover that it’s difficult to say what the future might bring next for this nascent industry. All innovations require time to reach maturity and mainstream acceptance, and crypto is no different. Just think about how people reacted when computers, the internet, or social media emerged. These tech developments were met with reluctance and resistance because they were new and unfamiliar and people naturally fear and reject what they don’t know or fully comprehend. But they eventually warmed up to them and here we are today, using all the above-mentioned innovations on a daily basis. 

Every invention goes through the exact same process. So, crypto’s volatility is partly caused by its newness. Digital assets simply haven’t been around for long enough to build legitimacy and establish themselves as trustworthy players in the financial system. They’re still in their price discovery stage when stakeholders speculate on their value and potential. Until we have a better understanding of what cryptocurrencies can do and how they could benefit us, their price is bound to experience constant swings and investors, keeping many traders and investors at bay.  

Decentralization 

One of the reasons digital currencies became so popular is decentralization. In other words, crypto is not governed or controlled by any entity, which in theory could allow users to circumvent restrictions imposed by governments and financial institutions and take full charge of their finances. Although at the moment crypto is mostly used as an investment venue and less as a payment method and alternative to fiat money, the concept proposed by crypto could solve many real-world problems.

But decentralization is a double-edged sword that also works against crypto. Without a central body to oversee activity in the crypto market, users lack the normal safeguards they’d enjoy in traditional markets. Even if many countries around the world are currently working on developing regulatory frameworks for crypto in order to ensure a safe environment for traders and investors and instill consumer confidence, the legal landscape remains chaotic and confusing for the time being. This creates more uncertainty and adds to the already exacerbated volatility. 

Market sentiment 

With a short and tumultuous history behind it and not much clarity around what it can or cannot do, its use cases, regulations and future for that matter, crypto’s value is mostly based on market sentiment. And market sentiment is an incredibly fickle foundation to build upon. This means that the emotions and attitudes of traders and investors dictate what happens in the market. Because crypto lacks intrinsic value, its price relies largely on what people think it’s worth, and that makes digital currencies a highly speculative investment. 

A lot of people don’t really understand what they’re investing in. They just choose an asset that they think it might appreciate in the future, often influenced by media hype and FOMO and add it to their portfolio, hoping for the best. Needless to say, this strategy has caused many investors to lose their funds when their predictions didn’t pan out.  

Supply and demand dynamics 

Supply and demand also play an important role in crypto’s value. While the laws of supply and demand influence all markets, what makes the crypto’s situation different is the limited supply of many of its main players. For example, Bitcoin has a limited supply of 21 million BTC. Once this limit is reached, there will be no new coins entering circulation. Similarly, Litecoin’s hard cap stands at 84 million. 

Due to supply limits, entities that hold large amounts of crypto, also known as crypto whales, have the ability to influence price movements with their actions, and thus increase crypto volatility, whether intentionally or not. 

The latest crypto winter proves that volatility is still a major issue for this promising asset class. But as the market continues to expand and evolve, it might follow the same path that many other innovations have taken before it and this heightened volatility might eventually subside. So, crypto enthusiasts will just have to trust the process and see what happens.


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