Why is Cryptocurrency so Volatile?

The status of cryptocurrencies has reached the point where everyone has heard of them, even if they do not actually use them. These are essentially currencies that exist only in virtual or digital form and that are secured by cryptography.

There has been a lot of talk about how they represent the future of money. That is because they are able to bypass the institutions that act as financial gatekeepers – e.g., banks and governments.

However, what cryptocurrencies remain known for among most people is their extreme volatility. This means that their value rises and falls sharply on a frequent basis.

Despite that, many find trading in crypto an attractive way of trying to make money and often make an online investment in cryptocurrencies such as Bitcoin and Ethereum. It is advised for traders to use a secure trading platform as well as be aware of the volatility of cryptocurrency.

The Volatility of Crypto

The degree to which the prices and values of cryptocurrencies change has really been brought home to people this year, with crypto markets crashing twice since the start of 2022. During May, the Terra Luna coin collapsed in value, which took $500 million off the overall crypto market price and ruined a lot of investors around the world.

This was followed by a second crash in June, which has seen another $400 million wiped off the crypto market, taking its cap below the $1 trillion level. That is the lowest it has fallen since the beginning of last year.

Unsurprisingly, a number of people are unnerved by this, and it is making a lot of investors question whether crypto is a good trading option. As mentioned above, it does make some real sense for spread bets, which are essentially speculations on price rises and falls, but crypto is certainly risky as a standard investment right now.

Why is Crypto so Volatile?

The market volatility applies to all cryptocurrencies. Even Bitcoin – the original crypto and by far the one with the highest profile – has been known to lose 30% of its value in a single day.

There are a number of reasons why this market is so astonishingly up and down.

• Its newness

The fact that crypto represents something completely new and disruptive to the established financial order is a big part of its appeal to investors. However, it is also a contributory factor in the shocking market fluctuations.

That is because cryptocurrencies have yet to be fully accepted as assets in the way that standard currencies, gold, property etc. are. The absence of that acceptance means that the market can be disproportionately impacted by outside personalities or events.

An example of this would be the collapse in the Bitcoin valuation after Tesla publicly rejected crypto payments.

• Supply and demand

As an entirely virtual asset, a cryptocurrency value is decided solely by supply and demand and some of the currencies have quite restricted supplies. For example, the supply of Bitcoin is 21 million, which is lower than rival cryptocurrencies like Chainlink and Litecoin despite Bitcoin being the most known crypto.

This has led to big investors taking major Bitcoin holdings and driving significant falls and rises in its value.

• The regulation issue

There are persistent suggestions that Bitcoin, in particular, will become subject to state regulation, and every time such stories arise it impacts the value of the currency. Just now, the crypto market remains essentially unregulated though and that is also a factor in its overall volatility.

The lack of the sort of regulatory framework that governs other markets, such as those for bonds, equity, stocks, and hard currencies makes standard investors wary of getting involved.

This means that speculative spread betting on the crypto market falls and rises still dominates right now. The absence of regulation is probably standing in the way of the crypto market balancing out at this point.

• Youthful investors

The idea of crypto as a new frontier in finance and investment means that it is primarily attracting younger traders right now. These people are hoping to make money quickly via crypto investments, but they often do not have the capital to stay in the market when they lose following a crash.

These youthful investors entering and leaving the market constantly is helping to keep it very unstable.

What is the Future of Cryptocurrency?

The recent crypto market crashes occasioned a lot of smugness from those outsides of it as well as claims that the crypto hype was now over. That is pure wishful thinking from people who dislike the image of the 'crypto bro' and fear the uncontrolled and unregulated nature of these currencies.

The key to crypto markets moving from their current extreme highs and lows towards the healthy volatility needed within financial markets is bigger trading companies and institutions getting involved. For that reason, the recent decision by Elon Musk of Tesla to invest in Dogecoin is a step in the right direction.

Musk is very much an outlier though in that he is impulsive and a natural risk-taker. For more sober investors to make the move into the crypto markets, some form of regulation may be a necessary step, even if it is one that many will greet with reluctance.

There is no one single reason for the volatility of cryptocurrencies; it is a variety of different factors working together. We must remember this market is young though.

(Devdiscourse's journalists were not involved in the production of this article. The facts and opinions appearing in the article do not reflect the views of Devdiscourse and Devdiscourse does not claim any responsibility for the same.)