Why Are Crypto Prices So Volatile? Let’s unveil the mystery behind crypto’s volatility.
It is an undeniable fact that cryptocurrencies had made countless people happy when they were able to cash in on their profits before the market correction arrived. These days, however, the volatility of crypto prices can make even the most seasoned of investors palpitate. One day you’ll feel at the top of the world after having made millions in profits, a fortune that could also be reversed in a single day due to price fluctuations. One can’t help but ask why cryptocurrency prices are so volatile?
Supply & Demand
One way to explain the volatility of cryptocurrencies is to view them as a type of commodity governed by the law of supply and demand. Simply put, the more people want to buy a specific cryptocurrency, the higher its price in the market is going to be. Conversely, if nobody wants it and almost everyone who has it in the portfolio is selling, it will drive prices down.
This model, as simple as it sounds, can be used to explain the unprecedented rally of cryptocurrencies last year. With prices of these digital coins led by Bitcoin and Ethereum inching higher every day, most investors want a piece of the action, and the market was generally in a buying mode. It was no surprise then that crypto prices reached previously unheard of heights last year.
Similarly, the same type of model can be used to explain the sudden plunge of crypto prices this year. It is exactly clear what triggered it, but people suddenly wanted to sell their digital assets. It could be that people reached a point where the majority of investors felt that with the ultra-high prices back then, it was the perfect time to cash in on their gains. As they say – buy low, sell high. However, if almost everyone starts selling, then the trend will ultimately pull down prices. When people started selling cryptos en masse, there simply is no way to go but down.
The law of supply and demand might seem simple, but it’s actually infinitely tricky when you try to use it to predict price fluctuations. As you might have guessed, the price movement is only influenced when people start selling or selling their digital currencies. But what actually triggers most investors in selling or buying?
Some people blame bad publicity for spurring majority of investors in a selling mode thereby causing prices to plunge. Well, that’s actually wrong; people did start selling cryptos early this year when the media started churning out bad news one after another.
But let’s give it the more general term public or investor perception. When people perceived commodities or cryptos to be undervalued and have high hopes that it will increase in value, they’ll buy it no doubt. Conversely, if they perceive that a cryptocurrency to be rather shaky at the moment, whether the perception is backed by hard evidence or purely conjecture and hearsay, they’ll likely sell it to get rid of it while the price is still high.
As you can see, perception can be formed by news, testimonies, recommendations from friends, the words of a popular figure, a crypto expert or even some random ad you came across the net. In fact, BM Magazine blames the morning papers for setting the tone of the day in terms of how you view cryptocurrencies. One morning, when the news is peachy, you’ll want to buy cryptos. The next day when the papers start to print bad press, you’ll likely want to sell everything you got. Viewed from this perspective, you’ll get how complicated market forces could get when different people from all over the world are reading or exposed to different types of news or materials which may affect their buying behavior.
New and Relatively Small
While every commodity and currency is subjected to market pressure, why are cryptocurrency variations more volatile than national currencies like the dollar or yen for instance? It has something to do with the size of the current crypto market. At the moment, the value of digital coins is way too small compared to the value of the dollar or yen currently in circulation.
When it comes to volatility, size does matter. Say you throw a huge rock to a rock to a very small pond, the ripples it will create will look gigantic compared to the pond’s puny size. But if you throw the same rock in the ocean, the ripples it creates is virtually nothing compared to the ocean’s vastness.
The rock can be likened to a $500 million sell order. If you place it in the very small crypto market, it’ll inevitably create a downward trend in its price. However, if you play it in the bigger dollar speculation game, it’ll hardly create an effect.
In addition, the crypto market is very new. Last year, people were happy that the prices were climbing. But there were really no historical highs or lows to speak of then, so investors don’t know when to stop buying. The question was just how high is high enough?
Conversely, when prices started falling, investors don’t exactly know what price to stop selling. Others say that it is because digital coins have no intrinsic values, to begin with, but this is not entirely an accurate explanation. Given that dollars are no longer backed by gold reserves, it can likewise be argued that the national currency also does not have any intrinsic value.
A more reasonable explanation for the plunge is that cryptos do not have an extensive history yet by which investors can compare with. The good thing is that as the market matures, investors will learn from past trends and will not be so easily alarmed and willing to sell their holding even at rock bottom prices.