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Why is Cryptocurrency So Volatile: An Explainer

Cryptocurrency has become the top favorite investing option of fancy investors, but the market’s volatility is still previewed as a risky bet by most aspiring venture capitalists.

Here is a recent example depicting the volatility of the crypto market: continuing its bull run from last year, Bitcoin hits its all-time higher of $65,000 in April 2021, but in the very next month, the crash brought its value to stay below $30,000 throughout May and June 2021.

Similar patterns of sudden highs and lows can also be viewed in most of the other popular cryptocurrencies. While this may result in a windfall for some, many investors have lost significant amounts in this highly volatile market.

So, what is behind the volatility of the cryptocurrency market? Let’s delve deeper:

What Makes Cryptocurrency Market So Volatile?

Here are the top 5 major factors contributing to the volatility of the crypto market:

A Relatively New Market

The primary driver behind crypto’s volatility is its newness. Every new concept and technology takes time to settle and situate itself in the market, and the same holds for cryptocurrency.

Though the market is gaining a lot of traction, cryptocurrency is still a new sector while also causing a lot of disenchantment amongst investors.

Despite the widespread coverage, this market is still insignificant compared to regular currencies or even gold. This implies that even little causes, such as a group of people holding huge quantities of cryptocurrencies, may have an impact on the market. Even if they merely sold Bitcoins, it would be enough to decrease the price.

Regulation Problem

One of the most crucial element influencing the crypto market’s volatility is the lack of governing body and regulation issues. The sharp rise in the price has always halted every time a government has slapped regulatory brakes on the market, with governments adopting various methods to regulate the industry.

For example, when China stepped up its crackdown on crypto-operating businesses in November 2019, Bitcoin hit an all-time low. Replication of the South Korean government’s attempt to regulate cryptocurrency trading in 2017.

Unlike other asset classes that are governed or managed by an entity, cryptocurrencies are not controlled by anybody in the traditional sense, like fiat money, stocks, or bonds.

The Crypto market, by its very nature, is decentralized, with no ties to the national boundaries or specific government entities. However, policymakers accustomed to dealing with assets have a clear definition.

Therefore, its anonymity is what both attracts and repels investors.

Limited Supply and Major Holdings

Most of the cryptocurrencies present in the market, including the industry leader, Bitcoin, have a finite supply, unlike the conventional currency. Given the fact that Bitcoin’s supply is restricted to 21 million, of which about 19 million have already been mined, the demand and supply factor plays a vital role.

For example, Litecoin has a maximum supply of 84 million, whereas Chainlink (an Ethereum-based cryptocurrency) has a maximum supply mark of one billion.

Furthermore, since cryptos are digital assets, their price is solely controlled by supply and demand.

“It is true that the crypto market is more volatile than other markets. But the risk of volatility can be rewarded with high rewards (returns). So in that sense, volatility is not the enemy.” 

Because of a maximum supply threshold, entities owning a significantly large number of crypto also play a crucial role in the rise and fall of the market. Thus adding more to the overall turbulence.

Still in the Price Discovery Stage

The fact that cryptos are new is the fundamental cause of their volatility. All new ideas need time to settle and become accepted, and cryptocurrencies are no exception. The asset class, the market, and investors/speculators are all still getting their bearings. Therefore price discovery is still in its early phases.

Cryptocurrencies have acquired worldwide fame (or infamy) in recent years, but they are not as widely acknowledged as traditional assets like stocks or gold as an asset class. Growing market maturity and acceptability go hand in hand. As a result, when Tesla stated that cryptocurrencies would not be accepted as a form of payment, Bitcoin’s value plummeted. Tesla CEO Elon Musk, on the other hand, scribbled ‘Doge’ on his Twitter post, the price of the crypto skyrocketed.

Such influential events or personalities contribute to the volatility, much as when a well-known investor buys a company’s stock, the price of that stock tends to climb.

Therefore trading crypto is very speculative due to a lack of information and rules. Investors make speculative wagers on whether prices will rise or fall, resulting in a quick influx or outflow, resulting in significant volatility.

Speculative

Most investors are interested in cryptocurrency not as a currency but as a hedge against inflation. With an intrinsically valuable asset like gold or diamond backing up the digital currency, the crypto market is mostly dependent on speculation, which is essential, educated guesswork.

And infusing speculations in any investment is the sure-shot way to introduce volatility in your portfolio. 

Caution: The blog article is meant only for educational purposes. We don’t recognize ourselves as financial advisors. Therefore we advise to you conduct proper research and consult your financial advisor before investing your hard-earned money into the crypto market.

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