The extreme volatility of white label crypto exchange markets is well known. In the world of cryptocurrencies, large price movements that would be seen as huge events in traditional financial markets happen frequently.
Is this fluctuation a benefit or a drawback, though? Although most investors acknowledge that the value of cryptocurrency assets can change, only some are aware of the causes. This essay explains why cryptocurrency is so volatile to help investors better grasp the dangers and opportunities presented by volatility.
Volatility: What Is It?
In financial markets, volatility is the degree to which an asset’s price has risen or fallen over time. Larger and more frequent price changes indicate high volatility; the opposite is true for low volatility.
The more volatile and unpredictable an asset is often considered riskier as an investment. Compared to less volatile investments, this entails the possibility of higher returns or higher losses over shorter periods.
Crypto Volatility in Comparison with Traditional Markets
Since cryptocurrency is still a relatively new asset class, it is riskier than established asset classes due to its extreme volatility. For instance, equities exhibit a broad spectrum of volatility, ranging from the frequently volatile penny and small-size stocks to the comparatively stable large-cap companies (such as Google and Berkshire Hathaway). Bonds are even less risky since their prices fluctuate less dramatically than stocks, particularly higher-quality bonds like U.S. Treasury bonds.
The volatility of the cryptocurrency market is unmatched. This is confirmed by a cursory look at past price activity on charts, wherein cryptocurrency prices have experienced significant ups and downs at a rate far faster than that of assets in traditional markets.
As you can see from the example below, throughout its 14 years of existence, Bitcoin (BTC) has experienced more than eight 50% corrections. Nevertheless, Bitcoin has surpassed all-time highs by rising above each correction over a complete cycle.
Crypto markets are subject to price volatility for many of the same reasons as traditional markets. Similar to normal markets, cryptocurrency price fluctuations are driven by speculative activity and news events like COVID-19. However, because of the distinctive characteristics that define the nascent stage of the digital asset market, the effects of these events are sometimes overstated in the cryptocurrency industry.
Crypto Volatility Factors
Price discovery:
It takes time for new ideas to gain traction and acceptance in general, and cryptocurrency is no exception. During this early and rapid growth phase, the asset class, the market, and its investors/speculators are still getting established.
Since Bitcoin has only existed for 14 years—longer than most cryptocurrency assets—its price is still being determined. This implies that prices will vary more as more players join the market and attempt to agree on the fair value of digital assets.
Cryptocurrency is still seen as an anomaly compared to more conventional assets like equities or commodities, despite having become popular due to unparalleled adoption rates that have happened more quickly than other cutting-edge technologies (like the Internet).
Undeveloped Markets
Growing pains are inevitable with rapid growth. Many financial instruments and products are still in the early stages of development within the cryptocurrency ecosystem. Because cryptocurrency is more difficult for investors to obtain exposure to than assets like equities, it is heavily weighted toward retail investors. Although the use of cryptocurrency by institutions is growing, investors have limited options for managing their exposure to the asset class because derivative instruments and other forms of hedging are still in their infancy.
Because the cryptocurrency market is still relatively tiny, more depth or liquidity must be needed to support larger traders. In comparison, the size of the whole U.S. stock market at the end of 2022 was far smaller than that of the cryptocurrency industry.
Most trading in traditional markets is facilitated by major stock exchanges, including the New York Stock Exchanges (NYSE); however, cryptocurrency liquidity is dispersed among numerous exchanges. As a result, it is challenging for big players to enter or exit the market at “size” without changing the market and driving up prices.
Dynamics of Supply and Demand
The way supply and demand are distributed greatly influences how volatile and how much an asset’s price fluctuates. That is, however, especially complex in the cryptocurrency market because various digital assets have distinct supply patterns. Certain assets have a limited supply, frequently leading to circumstances where an abrupt spike in demand can drive prices higher and increase volatility. Given its limited quantity of 21 million coins, Bitcoin is the most well-known example of a digital asset with a fixed supply.
When big holders, also known as “whales,” purchase or sell substantial amounts of a certain asset, the pressure might increase, and the asset’s price may rise or fall. The current state of the cryptocurrency markets needs to be more efficient to withstand shocks to supply and demand without causing a large wholesale price impact. Smaller market cap assets are more vulnerable to the movement brought about by whale trades due to their limited liquidity. As a result, they are frequently riskier and more volatile.
Trading Around-the-Clock
The marketplaces for cryptocurrencies are always active.
Unlike regular exchanges like the NYSE, the crypto market trades from Monday to Friday during predetermined hours and is not closed. In addition to the absence of regulation, this implies that, unlike typical markets, there are no circuit breakers.
Exchange interventions known as “circuit breakers” are employed to reduce volatility brought on by panic selling or other damaging events that might occur inside or outside the stock market. The tremendous volatility in cryptocurrency’s free market dynamics results from the lack of guardrails or training wheels.
Final Thoughts
The cryptocurrency market is still extremely volatile, immature, and underdeveloped. Instead of being a flaw, this volatility is a feature and a necessary part of the rapid growth era of cryptocurrencies, offering possibilities and challenges to investors and traders alike.
Many of the causes that cause volatility will eventually fade. As the asset class matures, we will see less volatility in the future due to the entry of new players into the market, more institutional participation, and regulatory monitoring.
Invest in a personal broker now to better understand the cryptocurrency market’s volatility.
