Since cryptocurrency was first introduced, tokens in the market have experienced tremendous spikes in their value. Unfortunately, these heavy and frequent fluctuations have left some investors losing more money than they bargained for crypto trading. In fact, it is not uncommon to see people conclude on leaving the crypto market, tagging it “volatile”. However, many can’t place why it is or the cause of its high volatility. Why is crypto volatile? This guide explains in clear terms some of the common reasons for the volatility of the crypto market. It also discusses what you can do to cut down on the losses arising from crypto volatility.
What is volatility?
Volatility is an estimate of how much the cost of a specific asset has fluctuated over time. Typically, volatility is proportional to risk. This means that the more volatile an asset is, the riskier it is when you invest. Also, the more likely it is to offer investors either higher returns or losses over a short duration.
Volatility in the crypto market
As a relatively new asset class, crypto is extremely volatile. It has the potential for considerable upward and downward price shifts over shorter periods of time. When it comes to predicting the volatility of the future crypto market, nothing is ever certain.
This means that there are no guarantees that crypto’s volatility will ultimately mimic volatility patterns displayed in mainstream assets in the future. However, some experts claim that if this asset class continues to thrive and develop, it will probably continue to exhibit outsized volatility at regular intervals until it eventually reaches full maturity at some time in the future.
Why is crypto volatile?
So why is crypto volatile? Why are the prices of digital tokens always fluctuating, leaving many investors tense? Listed below are some of the causes of the high volatility of the cryptocurrency market:
1. Supply and demand
To grasp the concept of volatility in the crypto market, you need to first understand how the supply of these coins changes as more people purchase them and as their mining process keeps producing new coins.
When more people seek to buy and invest in Bitcoin, the token automatically increases in value because the demand has increased. The increased demand and finite supply of the token (only 21 million Bitcoins are available) creates an increase in price. This is because more individuals will be motivated to purchase them and more people will be willing to sell them. Hence, the Bitcoin market becomes very competitive and may result in a decline in price.
This is why cryptos that don’t have a lot of coins in circulation are generally more expensive than cryptocurrencies that have a lot of tokens in circulation. Essentially, when there are more coins of a specific crypto in the market (which means less demand), the price of the crypto will go down.
2. Cost of production
The cost of producing crypto tokens primarily depends on two major factors. These factors include:
- The hash rate of the network
- The total power consumption of the network
If the network is a proof-of-work system, such as the Bitcoin and Ethereum network, then miners have to vie to solve difficult mathematics and receive token rewards. The more rivalry there is for mining a certain specific cryptocurrency, the harder it is to mine it and the less profitable it is for people to keep mining it.
Theoretically, miners can give up their chase and switch to another reasonable cryptocurrency if their mining struggles are not paying off anymore. This can create short-term volatility in the prices of cryptos as miners move on to mining more profitable coins or even hold onto their tokens for a longer period. Unfortunately, this volatility may even influence the success of some tokens over the long term and may cause their market share to decline.
Therefore, as the cost of mining increases, the value of the cryptocurrency also increases. Generally, miners will not continue mining a coin, unless the value of the token is high enough to cover their mining costs. A typical example of a coin that mining fluences is Bitcoin. It is difficult to mine Bitcoin and this is contributing to its cost.
3. Speculation and hype
Another major factor that can contribute to the volatility of cryptocurrency is speculation and hype. When a new cryptocurrency gets launched, the coin typically undergoes an initial spike in price, which is born out of novelty, as most people will be hearing about it for the first time. Usually, this can cause people to hurriedly buy and sell the new token, which typically boosts the price to high and unsustainable levels.
Once people start to regard the coin as overrated and lose money on it, the speculation and hype die off fast, which eventually causes a price crash. It is very common for new cryptocurrencies to go through this experience. Celebrities and influencers can also contribute to the price swings of cryptocurrencies.
4. Regulations and legal requirements
One major factor causing lower prices of cryptocurrency is the volatility caused by the regulations set by governments around the world. For instance, China restricted Initial Coin Offerings (ICOs) and halted the trading of some cryptocurrencies in 2017. This made the price of Bitcoin decline significantly for some time.
5. Competition
Currently, the crypto market is saturated with thousands of coins, with new tokens and projects getting launched daily. Generally, when the competition between these coins becomes very intense, it may result in a drop in prices and a decline in the value of all cryptocurrencies, including the ones with a high market cap.
6. Crypto whales
Crypto whales are people who have large amounts of cryptocurrencies in their possession. Usually, these whales hold a considerable amount of cryptocurrencies and money and can cause a significant shift in the market by purchasing or selling considerable amounts of cryptos. This means that crypto whales can influence crypto prices, no matter the kind of cryptocurrency or its market cap, be that Bitcoin or Ethereum.
How do you manage volatility in the crypto market?
One of the best ways to reduce your vulnerability to crypto volatility and the general uncertainty in the crypto market is to diversify your portfolio across diverse crypto assets, and sectors, and use different strategies.
What is the solution to crypto volatility?
Currently, there is no permanent solution to the volatility in the crypto market because cryptocurrencies are still a relatively new asset class. The value and prices of cryptocurrencies are likely to fluctuate wildly, which makes them unpredictable and risky.
However, a new kind of cryptocurrency known as stablecoins has emerged as a possible solution to the volatility problem. The value of stablecoins is pegged to fiat currencies or gold, so it is unlikely that investors will experience excess volatility, as it is with any regular cryptocurrency. Many experts recommend that crypto investors with low-risk tolerance invest in stablecoins.
Which crypto is the most volatile?
With 500% staking APY, Bitcoin ETF Token is rated as the most volatile cryptocurrency in 2023. This token has a high-risk reward and an excellent ROI potential, however, its price can fluctuate very fast.
Why does BTC fluctuate so much?
The price of Bitcoin fluctuates because of the impact of supply and demand, cost of production, government regulations, media hype, investor and user sentiments, or any of the other factors listed above. All of these can work together to cause fluctuations in the price of Bitcoin or any other cryptocurrency.
How high can Bitcoin’s price go?
It is very common to hear people give their opinions on how high the price of Bitcoin will get. Unfortunately, all of these are just speculations and there is no certainty that it will work out as these people assume. It is unknown how high or low the price of Bitcoin or any other cryptocurrency will go.
Is Bitcoin safe to buy?
You are free to buy Bitcoin on a government-authorized cryptocurrency exchange. However, you should note that investing in Bitcoin is not generally risk-free due to the volatility. If you’re hoping to use Bitcoin to conserve your capital or even grow your assets, remember that its price is extremely volatile so there is no assurance that you will receive any returns. It’s a 50/50 chance. You’re even likely to lose all the money you invest and are likely to make gains from it.
Why are some Cryptocurrencies more volatile than others?
As an asset class (although a relatively new one), the value and price of cryptocurrencies are influenced by the same factors that can affect many other asset classes. Factors like supply and demand, government regulations, market sentiment, etc can affect cryptocurrencies. However, some cryptocurrencies may be more heavily affected by supply and demand or any other factors. Some coins become very popular, particularly if they have a very small market cap. Also, it could occur when they receive a large influx of new investors, which can drive up their prices.
Which is more profitable, ETH or BTC?
Bitcoin is more prominent, established, and mainstream than Ethereum, which makes investing in ETH a little riskier. As it is with most investments, it’s very possible that Ethereum’s higher level of risk offers its investors the potential for higher returns.
Ultimately, why is crypto volatile? The volatility of cryptocurrencies can be caused by different factors such as supply and demand, and the price of production. Market speculation and hype, government regulations, competition, and even crypto whales are major contributors too. The impact of some of these factors can also be heavier on some tokens than others. Therefore, this is why some coins can be more volatile than others in the market. It is recommended that you invest in crypto assets with only money that you are willing to lose. Also, to reduce your chances of losing in the crypto market, ensure that you diversify your portfolio by investing in stablecoins. Stablecoins are generally less prone to volatility, even though there are still some risks associated with them.
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