Understanding the Volatility of Cryptocurrency
In contrast to when cryptocurrencies first hit the market, most people have a pretty good idea of what they are—essentially, an alternative to traditional currencies that can be used to purchase goods or traded like any other investment. Most people also understand that stocks for significant cryptos like Bitcoin have proven viable over the years, despite suffering from varying degrees of volatility.
The subject of volatility first really started to enter the public eye with the rise, fall, and return of Dogecoin. It was a case study in the volatility of this asset, but many people were not fully aware of which factors were influencing the ebb and flow of this asset’s value. While it’s true that there’s money to be made in cryptos for early investors—or investors who buy dips betting on a rebound—putting your money on a cryptocurrency can often feel like a rollercoaster ride. In this article, we will demystify some of the factors driving this instability.
Lack of Inherent Value
This is probably the most widely discussed factor when it comes to unpacking the value of cryptocurrencies like Bitcoin. Unlike standard currencies like the United States dollar—which is backed by gold—cryptocurrencies have no intrinsic value. In many ways, they can be considered somewhat of an intellectual property. They have value because investors believe they have value.
The problem with speculative value vs. intrinsic value is simple: It is impossible to tell when an asset’s value is in a bubble. When other external factors influence public perception and investors begin to pull out, an investment with no inherent value can drop to zero. Because of this, cryptocurrency markets scare a little more easily because investors pull out when they feel a shift in public perception of the asset. This is because, naturally, they don’t want to be the one to lose money on the deal.
Earlier in the article, we mentioned Dogecoin as a case study for market volatility regarding cryptocurrencies. One of the most significant factors driving this volatility? Comments from public figures about the viability of the asset. More specifically, a series of comments on TV and tweets by Elon Musk in which he first hinted that he believed the currency was inviable, causing an immediate dip in the stock prices. However, he later retracted his views on Twitter with comments promoting the crypto as a worthwhile investment—causing Dogecoin stocks to experience a quick rebound.
This effect of these comments on the market could have been—and probably were—unintentional on Elon Musk’s behalf. However, they did have an apparent impact. Other prominent market gurus without scruples can—and have—intentionally made public comments to drive down stock prices, buying the dip and propping the currency back up to turn a profit. This is just one example of market manipulation that bears similarity to stock bashing and pump & dump schemes.
Emerging Market Issues
Bitcoin first came on the scene in 2009, around 12 years ago. While that may seem like a long time, it doesn’t amount to much in terms of market security. Particularly when we consider the fact that Bitcoin was the spark that lit the flame of an emerging market of cryptocurrencies that the public didn’t really begin to be taken seriously until several years later.
In short, the market of cryptocurrencies is still stabilizing. Any time there’s a degree of uncertainty, risk follows, and with it comes volatility. In addition, earlier investors who invested heavily in cryptocurrencies may sell off to enjoy the profits they’ve made—this can have two effects. Number one, it can cause the stock to dip by virtue of having so much money pulled out. Number two, it can signal to other investors that an early investor has lost faith in the currency and that a correction is due, causing a widespread pull-out that drives values down.
The crypto market notoriously scares easily. It takes time to build public trust in an emerging market. Suppose cryptocurrencies genuinely are the way of the future, like many in the crypto community believe. In that case, they should be around for decades to come, and this issue will begin to subside as the asset’s mettle is tested with time.
Regulatory Issues with Governments
Since the advent of cryptocurrencies, their legality and appropriate regulatory practices have been hotly debated both within the investor community and within governments across the globe, with the state of Hawaii banning the currency in 2014 before reversing this decision several years later. Though many of these factors have begun to recede from public concern, with various resolutions being passed that have helped open up the market to free trade, there are still some concerns over the lack of regulation.
Namely, Bitcoin has historically been associated with illegal purchases through avenues like the dark web. Some of the grittier purchases have made the asset radioactive to more conservative investors who worry about the crypto’s association with criminal activities. Though these issues are no longer a significant factor driving volatility and will likely continue to fall by the wayside with time, they were a major volatility factor during Bitcoin’s inception that may still contribute to public perception about the asset.
One of the things that makes Bitcoin and other cryptocurrencies so attractive is their mass appeal. There are countless stories of early investors who’ve made a fortune off the currency—as well as famous stories of missed opportunities like the one that inspired Bitcoin Pizza Day—and many of these individuals have true rags-to-riches stories, going from near-poverty to fabulous wealth as a result of their investment.
All of this makes this an appealing choice for relatively inexperienced investors who buy into cryptos the way some people buy lottery tickets. Because of this, the investor profile for a lot of these stocks can promote a high degree of volatility. Rather than being populated with knowledgeable investors who’ve built fortunes off of trade, or even average Joe investors who consult with financial advisors, many cryptocurrencies are propped up by individuals with no background in finance and who are swayed more by their emotions than the actual performance indicators of their investment.