Understanding Cryptocurrency Volatility

In addition to other attributes it has, volatility is an aspect of crypto you should come to terms with. If you are looking for a market where your investment grows steadily without the risk of losing your capital, then the crypto market is not for you as a result of cryptocurrency volatility.

This cryptocurrency volatility has made a segment of the general population believe that crypto should not be considered valuable. Some notable figures and institutions in the financial sector have debunked cryptocurrencies and advised the general public against investing in them.

The violent price swings, the very unpredictable nature of crypto, and the huge funds lost to some crypto investments can explain some of these negative sentiments. Also, the prices of some cryptocurrencies take a sheer drop and never recover. Cryptocurrency scams are also painting a bad picture for crypto investing and the crypto market.

Cryptocurrency investment is still one of the fastest ways to make money, though it could also make you lose money just as fast. Investing in the crypto market could make you a millionaire overnight or it could ruin you.

This article will help you to understand the dynamics of cryptocurrencies better.

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Why Do Cryptocurrencies Fluctuate So Much?

It is common to see crypto like Bitcoin and Ethereum rise or fall by 5% to 10% or more in a single day. You also notice fluctuations that have higher rates in small cryptocurrencies. So why do these cryptocurrencies fluctuate so much?

Demand and Supply: 

Just like most commodities, the value of cryptocurrencies hinges on the tango of supply demand. When the demand for a cryptocurrency rises above its rate of supply, the price will increase, and vice versa. The activities of the crypto market make the demand and supply of crypto erratic, hence cryptocurrency volatility.

Some factors determine the supply, these are:

• Mining: Mining is the process that generates new cryptocurrencies. 
• Max Supply: Some cryptocurrencies like Bitcoin have a limited maximum supply. Once that limit is reached, mining for that particular crypto ends. Some others have an unlimited maximum supply.
• Burning cryptocurrencies: Burning is a mechanism used to remove a fraction of crypto from circulation permanently.

Competition 

Today, over 19,000 cryptocurrencies exist. Some of these cryptocurrencies are featured in several projects and tokens that rival each other. 

A project that offers favorable returns of profit on investment will attract investors and increase the demand for the cryptocurrency the project is based on. Shortly, another project that improves on the limits of the former might be launched. 

If this project is based on a different cryptocurrency, investors abandon this former project and rush to capitalize on the new one. This makes the demand for the crypto incorporated into the new project to rise leading to an increase in its price. The cryptocurrency incorporated into the redundant project suffers a fall in price.

Cryptocurrency Exchanges

Currently, the number of cryptocurrency exchanges totals about 500. Exchanges are the major channels through which the trading of cryptocurrencies occurs. 

Generally, the more exchanges that a cryptocurrency is available to trade, the higher the demand for that cryptocurrency which ultimately leads to an increase in price.

This is why cryptocurrencies that are newly listed on exchanges seem to keep rising in value. 

Utility 

This refers to the purpose a cryptocurrency can serve. Some financial institutions, businesses, and other organizations can incorporate a particular crypto asset as a medium for transactions. This would lead to an increase in demand and a rise in the value of that cryptocurrency, with all other factors kept constant.

A cryptocurrency that was a medium for transactions can also be cast aside by these bodies suddenly. This will depreciate the value of such crypto.

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Are Cryptocurrencies Currencies Too Volatile?

The rate of cryptocurrency volatility differs from one crypto asset to another.

The crypto market has recorded major losses over the years after the prices of cryptocurrencies went up. Bitcoin, the first cryptocurrency to exist and the #1 cryptocurrency in terms of market capitalization is a typical example of how erratic the price of cryptocurrencies can get.

Analysis from Yahoo Finance gives us an insight into the major crashes that this particular digital asset has undergone in the last decade. In early 2011, Bitcoin had reached a value of $32 for 1 Bitcoin. By June of the same year, its price fell by about 99% bringing its value to around 50 cents.

In 2013, the value of Bitcoin was about $260 but by August of the same year, it suffered a major crash that pummelled its value by some 83%. In 2017, the value grew to a staggering $20,000 but by the end of that year, it crashed to $12,000.The pandemic also saw a huge slash in its price. 

February, 2020 saw the price of Bitcoin at $10,00 which fell to $4,000 in March. The value of 1 Bitcoin rose to an all-time high of over $64,000 in April 2021 and has been fluctuating ever since. Currently, the value of 1 Bitcoin is about $30,000.

It is a very rocky history, one that is shared by several other cryptocurrencies. The factors that cause these crypto crashes are numerous. The major ones include the activities of crypto influencers and cryptocurrency regulations. These factors determine the prospects of cryptocurrency as a whole and when they react negatively, the crypto market plummets harshly.

It might interest you to know that not all cryptocurrencies share this property of being volatile. Their value is not determined by the factors that contribute to the price of other cryptocurrencies. 

Instead, their value is tied to the price of stable assets like a fiat currency(especially the US Dollar) or a commodity like gold. These cryptocurrencies are commonly referred to as stablecoins.

Stablecoins offer an alternative, volatile-free option to crypto investors and they are almost risk-free.

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Is Cryptocurrency Volatility Higher than that in Stocks?

The crypto market is much younger than the stock market but both have certain underlying similarities. Currently, the factors that determine the value of stocks also play a role in determining the value of cryptocurrencies. 

Demand and supply, competition, utility, and other principles are shared by both crypto and stocks. The differences arise from the need for an intermediary, market liquidity, market security, and market dynamics. 

Both markets have witnessed crashes over the years and both have also recorded losses running into trillions of dollars. But to rule crypto as more volatile than stocks, or stocks as more volatile than crypto, let us review what volatility entails.

Volatility simply means instability, inconsistency, or fluctuation. As applied to the value of cryptocurrencies or stocks, it means the instability of their prices. It sums up whether their prices go up or fall erratically.

With all that said, it can be inferred that generally, crypto is more volatile than stocks. Of course, there are some exceptions due to the peculiarities of some particular stocks and cryptocurrencies. The factors that contribute to making crypto more volatile than stocks are:

• Less regulated: The stock market is under close monitoring by the government. Administrative bodies are set over the stock exchange and protect both the market and investors at large. The crypto market on the other hand is decentralized. This means it is not under the control of any government and financial system. This largely contributes to the instability of crypto.
• Cyber insecurity: The crypto market due to its unregulated nature and other features like anonymity makes it very conducive for scammers. Some crashes in the crypto market happened due to large-scale scams. The rate of scams in stocks is not as frequent and not as massive too.
• Market development: The stock market is over two centuries old and has evolved greatly. Cryptocurrency just began with the creation of Bitcoin in 2008, so the crypto market is still quite young and trying to find its feet. New cryptocurrencies are released regularly with a lot of fluctuations in their value.

All these factors make crypto more volatile than stocks but that doesn't rule out the fact that the stock market still suffers from periods of unexpected volatility.

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Can the Cryptocurrency Volatility be Due to the Market Being Manipulated?

Like any other market, the crypto market is prone to manipulation. Such manipulation involves using deceptive methods on the market with the motive of reaping gains from the ensuing turmoil.

The absence of regulation on the crypto market leaves it susceptible to manipulation. Manipulation is injurious to the crypto market. It increases the volatility of cryptocurrencies thus scaring off potential investors.

Manipulation comes in various forms, some of which are:

• Spoofing: Here an individual or group of individuals with mischievous intentions try to influence the price of a particular cryptocurrency by placing fake orders in large quantities. This tricks other investors into buying or selling more crypto. The trend in the price now adjusts to suit the miscreants, predisposing to cryptocurrency volatility. 
• Pump and Dump: Some investors agree to “pump” the value of a cryptocurrency by investing huge funds into it. The pump in value attracts other investors who are ignorant of the plot. As more investors are attracted, the value keeps pumping to a certain amount intended by the manipulating group. In a coordinated manner, they then “dump” the crypto at a high profit.
• Wash Trading: Certain groups of individuals agree and start buying and selling a particular crypto asset steadily. This will portray an increase in the 24-hour volume of that cryptocurrency on exchanges. A key statistic that attracts investors is this 24-hour volume and they invest ignorantly. As the price of the digital asset increases, the wash traders dump this asset causing a sheer drop in its value.
• Bogus news on social media: This time, the culprits propagate fake news on social media about a digital asset. This news may be aimed at causing panic in the crypto market or driving the prices of cryptocurrencies up.

You can escape being a victim of all these by verifying info on crypto from different, trusted sources and careful study of the trend in the price of cryptocurrencies. 

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Final Thoughts 

Besides the niche of stablecoins, cryptocurrencies are volatile. This volatility is fueled by the increase in demand due to increased awareness, launching of new crypto-based projects, social media trends, and activities of scammers.

The crypto market has seen monumental rises and titanic falls in the value of cryptocurrencies. This led to the advent of crypto non-believers.

But no investment is risk-free. The key to investing in cryptocurrency is to study and choose the right digital asset you want to invest in and be patient. Values depreciate but they appreciate also.

The key to investment is that certain cryptocurrencies will appreciate in the long run. Short-term volatility should not spook you as that is a core phenomenon of the crypto market.