One of the most frequent reviews of the address cryptocurrencies is that they are very volatile and, therefore, they are subject to great risk. This is an undeniable fact, because in recent years there have been dramatic increases in its price. followed by no less spectacular drops, close to 90% compared to the previous maximum.
Many factors explain why cryptocurrencies are so volatile. But above all, it helps to understand if the same cryptocurrencies will continue to suffer from this volatility in the future. Next, we explain some of the most important ones.
Volatility and Reason for Cryptocurrency Price Fluctuations
volatility is one the measure of the frequency and intensity of changes in the price of an asset with respect to its standard deviation. In simpler terms, it serves to explain the intensity of up and down movements in the market.
There are various reasons that explain why volatility occurs in an asset. In the case of cryptocurrencies, the reasons are not very different, although there are a number of nuances that explain why they are currently undergoing so many changes in their prices.
Cryptocurrencies are highly volatile as they are influenced by the law of supply and demand, investor sentiment, and the influence of media as well as social media. All of these factors, added to the fact that it is a new small cap financial asset, cause the price to fluctuate wildly.
We will now detail these factors.
Cryptocurrencies are a whole new financial asset
As economists explain, all recently created financial assets is subject to market volatilityespecially when there is a volume of transactions as large as what happens daily in the cryptocurrency market.
But it is that in addition, it must be taken into account that cryptocurrencies were born with the vocation of replacing, or at least complementing, physical currency properties. However, this monetization process is not simple, let alone fast.
It must be adopted massively by all citizens and be used regularly in the sale of products. Something which, for the moment, That’s far from being the case.
speculative factor
Speculative practices play a very important role in the price volatility of cryptocurrencies today. And not only because investors are looking for very fast returns (sometimes almost immediate), but also and above all, by arbitration.
This practice consists of buying cryptocurrencies in a Swap and resells them quickly in another, thus taking advantage of the price difference between these platforms.
May due to the lack of standardization and the absence of an organized market where cryptocurrencies are listed, as there are with other assets such as stocks or bonds. A real opportunity for traders to make quick profits, but leading to more volatility in the price of these assets.
The work of opinion leaders and influencers
When an authoritative voice makes a certain relevant announcement about cryptocurrencies, the market reacts quite quicklyshoot or bring down its price quite remarkably.
The most paradigmatic case of this trend is that of Elon Musk. On several occasions, the owner of Tesla and SpaceX triggered the price of Bitcoin with a single tweetespecially when he announced that Tesla was accepting cryptocurrency as payment.
Later, Elon Musk himself backtracked, announcing that Bitcoin would no longer be accepted as a means of payment due to the increasing use of fossil fuels for its operating process. The result is already well known to everyone: a 20% crash of cryptocurrencies in just a few hours.
regularly
It is not very clear whether the regulations growing demand for cryptocurrencies or on the contrary discourage its use. It should not be forgotten that cryptocurrencies are essentially decentralized, with a clear vocation for deregulation. And so investors understand.
The gradual increase in regulation could pave the way for greater adoption, at least among less experienced savers. However, if the regulations are too strict, it could have the opposite effect.
The case of China perfectly illustrates how regulations (and bans) have a huge impact on the price of cryptocurrencies. In September 2021, the Asian country declared all cryptocurrency transactions illegalcrashing many of them, especially Bitcoin.
whale activity
In the crypto universe, there are a small number of people who amass a good portion of the total volume of digital currencies in circulation. They are known as whalesin a clear allusion to the movement of these mammals in the ocean.
Theoretical, whales hold enough cryptocurrency volume enough to manipulate their grades if they wanted to. And sometimes they do, selling and buying large amounts that have a huge impact on their price.
There are no solid institutional investments
One of the main problems with cryptocurrencies is the lack of institutional support. With the exception of El Salvador, which was the first country to declare Bitcoin as legal tender (a risky bet), no other nation in the world has encouraged its use. Moreover, the tendency is rather to put a spoke in the wheels of these assets.
Indeed, to date, the markets do not trust cryptocurrencies as much as fiat currencies, the supply and inflation of which are controlled by central banks.
Lots of misinformed investors
Everybody know the success stories of investors with little prior knowledge they made millions in days investing in cryptocurrencies. Or, if you’re unfamiliar with them, you’ve probably heard about them in the press or online advertisements.
This has led many unsophisticated investors to invest in cryptocurrencies, driven by emotions or a feeling of FOMO (Fear of missing out or «fear of being left behind»). Thus, they buy and resell these assets, albeit often in a completely unjustified and somewhat random way.
Stabilizing cryptocurrencies: when will they reduce their volatility?
It is not easy to predict what will happen in the future with the volatility of cryptocurrencies. Logically, the protocol improves as new digital currencies emerge, and existing ones have an ever-increasing transaction volume that serves to smooth out, in a way, these fluctuations in the markets.
But in addition, other more stable assets have appeared which aim to reduce this volatility. It’s the case «stable currencies» (As the Currency USD), a type of digital currency that seeks to control its fluctuation through algorithms or by linking it to fiat currency, tangible assets (gold, real estate) or another cryptocurrency, making them less volatile.