The Volatility of Cryptocurrency
The volatility of cryptocurrency is one of the major reasons why many people refuse to invest in the digital currency. The key reason for cryptocurrencies volatility is their newness. Throughout history, there have been many new phenomena’s that have taken time to settle down and be accepted and the same holds true for cryptocurrencies. The asset class, the market as well as investors and speculators are still finding their feet and so it is still the initial stages of price discovery.
Due to the lack of understanding and rules, at present time trading cryptocurrency highly speculative. Investors bet on the prices going up or down, and these speculative bets cause a sudden influx or outgo, leading to an increase in volatility.
Here are some of the major factors that contribute towards cryptocurrencies high levels of volatility.
Lack of A Controlling Agency – When compared to other asset classes that have some sort of governing or controlling agencies, cryptocurrencies are by their very nature not controlled by any entity in the traditional sense as fiat currency or equity or bonds are. The anonymity is what attracts investors or makes them sceptical.
The Sentiment Factor – When cryptocurrencies become even more popular and become more accepted, more investors will understand the factors that influence their movement. In the meantime, a lot of the movement is speculative in nature as investors are buying or selling based on sentiment.
Limited Supply And Major Holdings - In comparison to traditional fiat currency, some cryptos such as Bitcoin are in limited supply. Bitcoin supply is limited to 21 million, but since it is among the most popular cryptos, demand and supply forces come into play. For example, Litecoin has a maximum supply of 84 million, while Chainlink’s (Ehtereum-based) limit is 1 billion. Furthermore, cryptocurrency is a digital asset, the price is determined entirely by the laws of supply and demand.
Even those who are looking at cryptos for the long term are doing so as they believe that the asset class will gain acceptance. Tesla’s Musk, for instance, explained that he owned Dogecoin because many of the employees at Tesla and SpaceX own Dogecoin.
Furthermore, a large number of young investors are putting money into cryptocurrency with a motive to invest and hopefully earn quickly. As a result of this when they lose a big amount, they usually quit the market, leading to volatility in the market.
Emerging Market - Cryptocurrency is still an emerging market, gaining rapid popularity as well fuelling quick disenchantment among investors. Despite all the media attention, this market is still tiny when compared to traditional currencies, or even gold. This means even smaller forces a group of people holding large amounts of crypto coins can influence the trade. Even if they sell only Bitcoins, it would be enough to crash the whole market.
“The market is in its infancy and in the absence of controls there will be years of volatility, understanding that there are underlying conditions that change rapidly will means that there will be constant fluctuations over the short and medium term,” says Craig Dangar.
Developing Technology - The blockchain or other alternative technologies on which these coins operate are still evolving. It has only been a decade since the Bitcoin idea was first proposed. There is the scalability problem, when a smart contract is not validated with the timeframe expected, creating sudden downward pressure.
