If you have any knowledge of the crypto market, you know that it’s highly volatile. Major price swings are regular occurrences in the sector, and while some investors find market volatility desirable, many are afraid of it because they don’t know what to expect from.
The crypto market has experienced great expansion over the last couple of years and it provides countless investment opportunities, especially for those who aren’t afraid to take a risk. Volatility is one of the main features that characterizes digital currencies, but in order to use it to one’s advantage, they have to identify the factors that power it. Extreme fluctuations in price have resulted in losers and gainers over the years, regardless of the crypto project they put their money in. Those who buy Bitcoin p2p know that the outcome can vary according to the timing with the market and other similar factors.
Suppose you’re new to crypto, you might not know why cryptocurrencies are volatile assets. To answer this question, continue reading this article.
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What is crypto volatility?
Do you have any knowledge of traditional finance? If you do, you might know that volatility is the measure of dispersion of an asset’s value over time. It provides information about the asset’s average value and the market price fluctuations. Regardless of the nature of the asset, the higher its volatility, the riskier to add it to your portfolio.
Volatility works the same for digital currencies, it refers to their value fluctuation or unpredictable changes in their prices. Bitcoin and Ethereum are well known for their fluctuations over the years, but they’re not the only cryptocurrencies with huge changes in their prices.
Blockchain-based currencies can experience wild swings over a couple of minutes or hours, and their volatility can result from several factors. If you want to get involved with the crypto market, it’s essential to understand how volatility works.
A list of factors that impact crypto volatility
Cryptocurrencies are a relatively new asset class, but they are some of the most volatile in all financial markets, and often act erratically. Here is why they do it.
Price discovery
When a new concept is introduced on the market, the public needs some time to accept it, and the same holds true for digital currencies because the idea of a new asset category took some time to settle. And even if the cryptocurrencies are part of the financial sector for some years now, investors are still finding their feet when it comes to adding them to their portfolios because they want to ensure they don’t expose them to unnecessary risks. Bitcoin is the oldest digital currency and has been around for more than a decade, but the other cryptocurrencies are still in the price discovery phase. It means that their prices will experience further fluctuations because new assets enter the market every day and the market tries to establish a fair value for each digital asset.
Digital currencies are closer to entering the mainstream as the increased adoption rates show, and they move faster than other innovative technologies. The market maturity is closely connected to the growing acceptance of the public. If people trust that they could gain from investing in crypto, then price discovery will continue to have a huge impact on crypto volatility.
Market maturity
A market that grows rapidly, won’t do it without consequences. Therefore, unsurprisingly people don’t trust that the crypto market has reached its full potential because even if it gained popularity and expanded rapidly, it’s still in a development process, with new instruments and products being added. Investors find it more challenging to gain exposure to blockchain-based assets because they rely on technology not many understand. However, we have witnessed an increasing institutional adoption of crypto, so even if some projects are still in their early stages, investors feel more confident to open their portfolios to this asset category.
However, the small size of the crypto market doesn’t accommodate large traders, who wait for its expansion, so they can join it.
Supply and demand
As with all the other assets, the supply and demand play a crucial role in the level of volatility the asset class is experiencing. However, the relation between the two plays a paramount role in the crypto arena because it has unique dynamics. The limited supply of some crypto assets generates conditions where the demand is high and therefore boosts volatility. Bitcoin is the best example for this because it has a limited supply of 21 million coins, and therefore people feel the pressure to get theirs. The pressure gets even higher close to halving events or times when whales, or large holders buy significant quantities of coins. Whales usually decide when crypto prices soar or tumble because they have purchase power and can acquire the entire supply of an asset at a particular time. The crypto market is still young to handle such supply and demand shocks without affecting the prices.
Market sentiment
Considering that cryptocurrencies have grown in popularity because people trusted the backbone technology, it’s normal for the market sentiment to be a factor that influences volatility. It all comes to the psychology of the crypto investor, who can be highly or less informed about the movement of the crypto sector. Beginner investors are usually easier to impress than seasoned ones because they would blindly trust whatever the project developers promote. They also fall victim to FOMO which is common among speculative assets. There are many cases of FOMO purchases during bull markets when people tried to make a profit from entering the market only because other traders did it. However, this loop is far from beneficial when dealing with cryptocurrencies.
Closing thoughts
Knowledge of the crypto sector is essential regardless of the experience of the investor. Volatility is a factor that impacts the evolution of digital currencies and only by understanding the conditions that power it, an efficient risk management strategy can be crafted.
