According to CNBC, the overall cryptocurrency market cap surpassed $2 trillion in April 2021. The big turning point marked the asset class's emergence as a serious contender in the global financial markets.
Despite cryptocurrencies' impressive history and development, the issue of volatility continues to plague this fledgling industry.
What is Volatility?
Volatility is a statistical indicator of how the price of an asset fluctuates or moves over time. Cryptocurrencies, for example, have aggressive price swings that swing from extreme lows to extreme highs in a short period of time. Investors and market participants can determine an asset's risk by understanding its volatility.
The asset with the highest volatility is usually referred to as a high-risk investment, and it often yields high returns (or losses). Forex, cryptocurrency, stocks, and derivatives are all highly risky investment options, whereas gold, shares, and a savings account are not.
The pros and cons of volatility
The benefit of volatility, especially in the case of cryptocurrencies, is that it keeps the market active, allowing for lucrative trading opportunities. Volatility also piques people's interest in cryptos, which tends to raise awareness and increase the market indirectly.
On the negative side, the extreme volatility of crypto, especially Bitcoin, may deter investors. Traditional investors, who are mainly risk-averse, don't like the volatility surrounding crypto rates. Despite the high crypto uncertainty, there has been an increase in institutional investors.
Factors affecting volatility
The crypto market operates in an extremely volatile environment. Cryptocurrencies have a very high risk-to-reward ratio. The following are some of the main factors that contribute to the high volatility:
Infant market
Bitcoin was first introduced to the market in 2009 and has seen tremendous growth since then. When compared to conventional investment options and currencies that have been around for a long time, crypto technology is still relatively new. Currently, crypto purchases are fueled by hype and speculation about potential disruption and adoption. There are still only a few quantifiable metrics that can be used to have a long-term perspective.
Low liquidity
Crypto has very poor liquidity as compared to other easily traded assets such as US equities and Treasury bonds. The volatility of the market has been influenced by the market's infancy and the relatively slow mass acceptance of cryptocurrencies. Worse, a low-liquidity market is vulnerable to market manipulation, resulting in frequent pumping and dumping.
Regulated market
Cryptography is based on complex and open-source technologies, making it difficult to control. Since there is no specific regulatory structure for dealing with such dealings, the market is vulnerable to exploitation. Crypto exchanges have been accused of manipulating their trading volumes to create the appearance of increased demand, resulting in abrupt pumps and dumps into these markets and price swings in either direction.
Speculation
The utility and rate of adoption of an asset determine its worth. Many cryptocurrencies' usefulness has been questioned, resulting in increased cryptocurrency volatility. The majority of people join the crypto industry because of the excitement and "get rich fast" aspects of it. The market's uncertainty has been exacerbated by such emotional investing.