Understanding Volatility In Cryptocurrency
Volatility is a measure of the fluctuations in the price of an asset. Volatile currencies experience a rise or fall in prices and when it comes to cryptocurrencies, volatility has long been singled out. Some do not hesitate to use the extreme volatility of cryptos to downplay their interest. Others go further by viewing it as an Achilles tendon that will prevent the massive adoption of cryptos.
Understanding Cryptocurrency Volatility
The price of cryptocurrencies is often volatile. Even the most famous cryptos like Bitcoin and Ethereum can undergo large movements relatively quickly. Hence, the prices of Bitcoin and Ethereum, for example, have been going through a bull run trend with a significant increase.
Let’s find out about the main characteristics that play on the price of cryptos.
The Law Of Supply and Demand
Cryptocurrency obeys the law of supply and demand. The demand is made up of people entering crypto investing; the more reputable a crypto, the more its demand increases. Similarly, more accessible crypto with a large number of exchanges available increases demands and vice-versa.
The Competition Between Cryptocurrencies
The competition between cryptocurrencies is also played on demand. For instance, just a few years ago, Bitcoin was by far the leading figure in cryptos. If an investor decided to invest in crypto, there was a good chance it would be in Bitcoin. Even if Bitcoin remains the number one cryptocurrency in terms of capitalization, other heavyweights are asserting themselves, such as Ethereum, Ripple, Binance coin and Litecoin, etc. These cryptocurrencies have characteristics that are unique to them and have something that attracts investors.
The offer is very simple. For instance, there are only 21,000,000 bitcoins available to be mined. Hence, the demand is controlled because there is a total number of available BTC. This unique feature compared to fiat currencies helps guarantee Bitcoin’s upward trend in the long term.
Crypto Market Volatility
In general, cryptocurrency volatility is in a completely different league entirely. Most crypto observers also agree to this. Crypto price volatility has no indices for measurement. However, in contrast to the prices of assets in the traditional market, which follows a regular pattern, you need to study historical price charts to see the ascending peaks and depressive troughs, which occur quickly.
After an initial rise of 125% in 2016, Bitcoin price rose to over 2,000% in 2017. Following the peak that saw it hit a new all-time high, we witnessed another fall in 2018. In subsequent years, Bitcoin’s price has continued to rise and fall. In 2021, Bitcoin reached a new all-time high and presently, it has achieved more than triple the peak price it attained during the bull run in 2017.
There are many reasons for price volatility in the mainstream markets, the same also for cryptocurrency. In both the mainstream market and crypto market, news development and speculation are major factors responsible for the price increase. However, since the crypto market has little liquidity than the traditional market, the effects of these factors are excessive since crypto markets have no strong ecosystem of large trading firms and institutional investors.
Intensified volatility and an absence of liquidity can build a range combination because both support each other. Other than Bitcoin, most other cryptocurrencies also lack established and widely adopted derivatives markets. Under the wiggle of day traders and speculators, crypto prices sometimes show healthy volatility of the type we see in mainstream markets.
But there are signs that volatility in crypto markets is going around a nook. Institutional investors and trading firms are starting to enter the asset class with more conviction. A derivatives market for cryptocurrencies is also starting to take shape as part of the development and expansion of the broader crypto market ecosystem.
Whether crypto volatility will someday mimic volatility patterns present in mainstream assets is still to be determined. But, as the asset class continues to grow and develop, it will make it possible to regularly show excessive volatility until it attains full maturity in the future.
How Is Volatility Measured?
People often want to know how volatility can be measured. However, when measuring volatility, they often refer to historical volatility– usually derived from a detailed study of prices over a specific time (frequently one month or 12 months). So, after the study, implied volatility — a prediction of price movement in the future is made. And since no one can precisely predict the future, it’s a less exact science (though it is the basis for widely used financial tools like the Cboe Volatility Index, nicknamed the “fear index,” which predicts the next month’s stock market volatility). But, quantifying volatility can be achieved in several ways.
You can estimate an asset’s standard deviation, which is a means of measuring the divergence of the price of an asset from its historical average and you can also measure how volatile one stock is relative to the broader market (the typical benchmark is the S&P 500). This method is called Beta.
Learn about the crypto volatility index on Twitter too to understand volatility trends.
Are There Ways To Reduce Crypto Volatility?
Most crypto investors believe high volatility is part of the interest — creating a likelihood for high returns. Even as Bitcoin’s volatility seems to be falling, it still moves by a double-digit percentage in a single week, allowing for strategies like “buying the dip.”
However, strategies are used by less risk-tolerant investors to limit the downside effect of volatility, such as dollar-cost averaging. Most investors with longer-term strategies usually have good reason to believe that an investment will eventually surge over time, so they don’t need to think much about short-term volatility.
In addition, there are now cryptocurrencies developed to have low volatility called stablecoins such as USD Coin, Tether and Dia, etc. — these stable coins have their price pegged to a reserve asset like the U.S. dollar.