One question that pops up regularly is, Why are the cryptocurrency markets so volatile?
Volatility is an important metric for traders and investors because it measures how wildly price swings over a specific period of time. The more volatile an asset is the riskier it is to hold onto it. Of course, if your investment strategy is to buy and hold, then volatility means much less to you than it does the investor who is constantly trading assets. Volatility itself is a measure of risk and investors who do a lot of trading tend to hedge their bets against volatility by investing in assets that are more stable.
The Bitcoin Volatility Index measures the volatility of bitcoin compared to other assets like silver and gold. It’s only one measure of risk, not the sole measure, but it is important to consider when investing in risky assets like cryptocurrencies. A bigger question is, what causes it?
4 Causes of Cryptocurrency Volatility
There are four primary causes of cryptocurrency volatility.
- First, infant markets are often volatile because there is no historic pattern established. Being that cryptocurrencies have been around only for about twelve years, there are still many market conditions crypto investors have not been through. That contributes to volatility.
- Lack of regulation also contributes to volatility. Regulations tend to place restraints on market activity and investor actions. Sans those restrictions, investors are likely to take more risks in the market and that causes volatility.
- Speculation is another contributing factor. While lack of regulation leads to speculation, it’s important to point out that speculation itself is an independent factor that contributes to the volatility index of an asset. After all, even in a highly regulated market, investors could impose a high degree of speculation. In the case of cryptocurrencies, speculation leads to more volatility and it is often new altcoins that see the wildest swings in price and value in short periods of time. This is due to a lot of speculation in the markets as investors bet on potential winners and losers.
- Finally, media hype causes volatility because the sheer number of new cryptocurrencies that enter the market daily coupled with the amount of speculation leads to many cryptocurrencies attracting attention when they don’t deserve. One example we’ve seen in the last year is with Dogecoin. One tweet from Elon Musk, a billionaire with a lot of social media influence, led to Dogecoin’s value skyrocketing in a short period of time. This kind of media attention feeds more speculation and the hype caused by the media attention in turn contributes to additional volatility.
The following meme shows how these four contributors to crypto volatility continue to influence the crypto markets and are likely to continue contributing for volatility for a long time.
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