Cryptocurrency volatility explained
Volatility is about change and fluctuation. The fact that assets go up and down in value is the very essence of trading, and trading becomes very interesting when markets fluctuate dramatically. Knowing when to make the right trading decisions can result in some considerable profits.
Of course, part and parcel of volatility is that uneducated trading decisions s may lead to large losses. This is something traders in the traditional stock and commodities markets are aware of.
So why is cryptocurrency volatility such a big deal?
Essentially, because it’s very pronounced. With a commodity such as gold, you can reasonably expect volatility levels of around 1 to 1.5%. Major currencies are less volatile, with a standard deviation of daily returns of between 0.5 to 1%.
Cryptocurrencies are well known for their volatility ranges which are upwards of 10% - Nonetheless, there are trading periods, where technical and fundamental market catalysts can trigger fluctuations of 20-70% or more. Upwards and downwards fluctuations as such, hardly go unnoticed.
What makes cryptocurrency so volatile?
There’s no one answer to this question. Volatility is affected by many different factors, including:
Basic supply and demand: As with other assets, interest is not always aligned with availability. When a specific cryptocurrency has more demand by traders or investors than the current supply, due to perhaps market sentiment, anticipation and fundamentals, the price is likely to move upwards. Conversely, when there is more available supply of a cryptocurrency than current demand, the price will result in a downtrend.
Public sentiment and perception: Volatility is affected by how people perceive cryptocurrency: media buzz and fawning editorials in the mainstream press might make interest in a coin go up; criticism and condemnation might make it go down.
For example, when JP Morgan CEO Jamie Dimon criticised Bitcoin in September 2017, we saw a temporary downturn in price. But global interest in Bitcoin soared towards the end of the year, and this contributed towards a massive upswing and an all-time high valuation.
Smaller market size: Put simply, the cryptocurrency market is significantly smaller than the foreign exchange market. To put it into perspective, the size of the foreign exchange market is approximately 5.3 trillion, whereas, cryptocurrency is 370 billion (at the time of writing). Circulation is restricted in many cases: for example, there are only 21 million bitcoins in to be mined, where 16,909,325 are in circulation; and 84 million litecoins where 55,552,031 circulating respectively. Some aren’t finite, but crypto market sizes remain small compared to major fiat currency markets.
This means that wealth distribution is invariably skewed, and that ‘whales’ – individuals who own a large amount of the cryptocurrency – can have a significant influence over the coin value. It also means that smaller market movements can have a bigger impact on the price than might be the case in major fiat currency markets.
Varying perceptions of the intrinsic value of the cryptocurrency: people all agree on what cryptocurrency’s ‘true’ worth is. Some are probably buying it without really believing that it can function as a store of value or wealth, while maintaining a belief in its underlying technology – and its transformative potential.
Is volatility good or bad?
Well, that depends on where you’ve put your money. Investments are all about risk: if you’re unwilling to shoulder any at all, you should probably consider other means of making money. Some bets will come off; some won’t. It’s all part of the excitement, and the frustration.
But volatility is ultimately a more important consideration for short-term traders, who take advantage of price changes to make a profit. If you’re going to ‘hodl’ your crypto for the long-term, then it’s probably less important.
Nonetheless, it would be a huge mistake to ignore volatility. It can change your plans for good or ill.