Why are crypto assets so volatile?

Can you imagine what it feels like if you’re holding ₹100 in your wallet, and its value suddenly drops to ₹60? You may have wanted to buy butter, but now plain bread will have to do. Then, just when you are reconciling to your fate, it jumps to ₹120, before plunging again.

Feel those knots in your stomach?

Well, that’s exactly how most traders feel almost every day, especially in the crypto market. That’s what volatility often does. Thankfully, not every asset or crypto is as volatile as the one in the example above. But why does it happen at all? And what exactly is volatility?

Crypto volatility

Volatility is part of the basic nature of most assets. The term “rollercoaster ride”—with all of its wild ups and downs—captures what crypto assets go through every day. That rollercoaster ride is what we call “volatility.”

Volatility is what makes the prices of assets go up or down, and it can depend on a variety of very specific factors—from something as basic and regular as the fact that crypto is digital to something as irregular as a hack. (Details on these factors come later in this article.) But broadly speaking, volatility is related to demand and supply.

To understand what that means, picture this: The ₹100 note you have in your wallet has turned vintage. It is the last note of its kind in the city, and people are fighting for it. The demand is insane. While the demand lasts, you might even get ₹1,000 for it. Clearly, your note’s improved value has to do with the increased demand. Then, suddenly, every person in the city shifts to digital payments. The ₹100 note is no longer being accepted across stores. Now there is ample supply, yet not enough need for it. You may have to sell your note for far less, say ₹60. This kind of sudden price action, a.k.a. volatility, is related to demand as well as supply.

We are quite sure you understand by now but let’s turn to an example from the world of crypto to clarify.

The case of Bitcoin

Since its inception, Bitcoin—like most cryptos—embodies the term “volatility.” Bitcoin was worth about $20,000 in December 2020. In January 2021, it hit $40,000 (roughly ₹29.70 lakh). In April, a new peak of $65,000 (around ₹48.27 lakh) was reached. This was followed by a June crash below $30,000 (approximately ₹22.28 lakh). Around 20 July, the coin surged to $45,000 (roughly ₹33.42 lakh).

Those peaks and troughs you notice…that’s what crypto volatility is.

Cryptocurrency volatility: What are the triggers?

Volatility as a concept is pretty straightforward. But the answer to what causes it isn’t. We have a few explanations for why volatility occurs in crypto.

1. Crypto is still an emerging market.

Crypto is relatively new as a financial instrument. Even the most senior crypto on the block—Bitcoin—is barely 15 years old. This means that the demand–supply cycles are still fresh, and the scale is small. If you are a sucker for numbers, the crypto realm has a market cap of $1.00 trillion (as of 22 August 2022). In comparison, gold and the entire US stock market are valued at $11.62 trillion (as of 22 August 2022) and $26 trillion (on 30 June 2022) respectively.

Because of the smaller size of the market, even a few influences could have a more significant impact on the price of the asset, causing volatility.

2. Since crypto is digital, a lot depends on the community backing it.

Most cryptos are digital assets. They aren’t backed by anything physical. That means demand and supply relevant to the crypto are determined by those vouching for it.

The value and problem-solving ability of the project affects the demand. Users often factor in the existing price of tokens and the underlying network’s problem-solving ability to assess the growth prospect of a cryptocurrency.

With the entire identity base being digital, speculation and sentiments drive crypto demand and supply, adding to the volatility. (More on this below.)

3. Market sentiments can make prices go up and down.

The crypto market is sentimental. That means it responds erratically even to the smallest of developments, let alone bigger developments like forks and migrations across blockchains.

Some examples: China’s ban on Bitcoin snowballed into a corrective period for the market. And recently, the Ronin hack, which affected Sky Mavis, the body behind Axie Infinity, led to a correction of sorts. Even news of crypto being accepted at Tesla’s Hollywood charging station caused the market to rally a bit.

When big news breaks, it often evokes many emotions among investors, traders, and HODLers. Some of the most common ones are:

• FOMO (that’s the Fear of Missing Out), and
• FUD (Fear, Uncertainty, Doubt)

The bigger the news, the more volatile the market can be.

4. Security breaches are commonplace and are sometimes used to coerce investors to sell.

Financial security threats, hacks, and breaches are unfortunately pretty commonplace and can affect the price action of many different assets—be it fiat, commodity, or crypto. But there is an additional thing that we have seen happening with crypto security breaches.

Take the example of Youbit, the South Korean crypto trading firm. In 2017, it had to shut shop after being hacked for the second time. Youbit lost 17% of its assets in the attack, and the company declared bankruptcy. The news was then used to coerce investors into selling their holdings, which caused a demand–supply shift. And volatility.

This was not an isolated instance. Such crypto breaches unfortunately do get reported not only to inform and educate but to confuse people and manipulate sentiments.

4. The occasional ill-equipped project impacts market volatility.

If you have been following the market closely, you would know that the latest crypto correction, or rather crash, of May 2022, centered on Terra’s meltdown.

Projects like Terra which need to dump Bitcoin often to manage their goof-ups make the market prone to dips and more drastic fluctuations.

But remember, they are only a handful.

Is it always going to be this bad?

The short answer: Crypto volatility isn’t going to disappear overnight. If you are volatility averse, try HODLing.

The long version of that answer:

In a world where people can choose financial instruments based on their risk appetite, crypto comes across to some folks as a tech-heavy niche that’s better left to the more adventurous user.

It is true that to succeed in crypto, you need to Do Your Own Research (DYOR) and take a detailed look at the asset technicals and fundamentals. But with the right information, things do get easier. The more you know about the crypto you are buying, the less panic you will have when you have to wade through volatility. And you might end up being on the right side of a volatile move, managing to buy cheap and sell at a high.

Besides, some volatility prepares you for the road ahead.

FAQs