One of the criticisms cryptocurrency investing has had leveled against it is that it is inherently volatile. For people with low risk tolerance, that could be a problem. Easy solution: Don’t invest in cryptocurrencies.
Even then, a low risk tolerance doesn’t necessarily mean “don’t touch.” Using the dollar cost averaging strategy, one could invest in cryptocurrencies and see respectable returns over time. However, if you have a low risk tolerance, you might want to make the percentage of your crypto holdings in your portfolio small compared to other investments.
Of course, I’m no financial advisor so this should not be construed as financial advice. You should seek the advice of a qualified financial advisor before you invest in any asset, including crypto.
Why Crypto Volatility is So High
The Crypto Volatility Index measures the rate of fluctuation in the cryptocurrency markets. Assets that have wild swings in value over a short period of time are volatile in nature. A high volatility rating means the asset fluctuates in value rapidly over time so that it may experience extreme highs and extreme lows within a few hours or days. Historically, all cryptocurrencies have been volatile and there are reasons for this.
Today, Bitcoin’s volatility is at 93.49. Ethereum’s is at 105.98. The higher the rating, the more volatile the asset is expected to be in the next 30 days.
There are four primary reasons cryptocurrency markets experience volatility:
- New market – The first cryptocurrency, bitcoin, was introduced into the wild in 2009. That means the market is very new. Most cryptocurrencies have not had to survive an economic downturn or major economic crisis. Infant markets generally see higher volatility due to the nature of the market and economic factors.
- Lack of regulation – No regulation means there are few restraints on market behavior and that generally means investors engage in more risky behavior, which leads to price volatility.
- A lot of speculation – Since there is little history to go on, investors must speculate on how cryptocurrencies will perform over time. That means speculation is the norm. Speculation leads to higher volatility because it also means more money is moving around in the markets.
- Media attention – Cryptocurrencies get a lot of media attention, primarily for their novelty. Much of this media attention is hype and that causes many investors to act emotionally in response to the news they read. Media hype generally leads to more speculation and risky behavior, driving up volatility.
Volatility is Good for the Crypto Markets
Despite the wild swings in prices from one day to the next, crypto volatility is good because it keeps the markets moving. Being that crypto is still new, much of the media attention drives new interest and that leads to more speculation and more volatility. Here are the top 3 reasons crypto volatility is a good thing.
- It keeps cryptocurrencies in the news – Even as the volatility goes higher, bitcoin’s value continues to climb. This leads to more media attention. Every time bitcoin hits a new high, the media report on it. That draws more interest to the cryptocurrency markets and attracts new investors. Even when bitcoin crashes, that means more media attention. Some people walk away losers and vow to never invest again. That’s okay because bitcoin’s price always bounces back. Media attention is good for crypto because it keeps the markets moving.
- It thins the herd – When bitcoin crashed after its last bull run, many investors left dejected. They couldn’t stomach their losses. In reality, they sold when they should have held onto their crypto holdings. The market crashed, but it has since risen higher. When people lose a lot of money on an investment, they tend to get gun shy. That means they are reluctant to enter the market again. That decreases volatility and ensures that the market will continue to mature until volatility diminishes to a reasonable level.
- It keeps regulators on their toes – Eventually, financial market regulators are going to step in and introduce new rules to investing in crypto assets. It’s just a matter of time. You can argue that isn’t necessary or that it will hurt the markets, but history has shown that governments will step in and regulate when things get out of hand. It may take a financial catastrophe like the stock market crash of 1929. As much as regulation is often unwarranted, I expect that we’ll see the crypto markets regulated within the next decade. That will reduce volatility and lead to a more mature market.
Crypto volatility has its benefits. Someday, we’ll all look back on the halcyon days of crypto’s wild west and wonder how we didn’t lose it all. Until then, keep on HODLing.
This blog post is for informational purposes only. It is not financial advice.