Cryptocurrencies such as Bitcoin and Ethereum demonstrate the revolutionary potential of blockchain, but are held back by high volatility. Unlike fiat currencies such as the US dollar or Japanese yen, which are relatively stable in value, cryptocurrencies experience significant price fluctuations within a matter of hours.
An example of this is the 40% drop in the Bitcoin price from $7,900 to $4,600 on March 12, 2020, which surprised traders and investors. Ethereum also experienced a shocking price crash from $319 to $0.10 in just a few seconds on June 21, 2017. This drop was caused by sell orders worth millions of dollars, which brought attention to the extreme volatility of cryptocurrencies.
Whether you are an active cryptocurrency investor or a fan of the financial markets, this blog post will explore the forces driving the high volatility of digital currencies. Here’s why cryptocurrencies are more volatile than fiat currencies.
The Speculative Nature of Digital Currency Traders
Many traders in the cryptocurrency market are constantly trying to make small profits here and there. That is why you will find an unusually large number of scalpers and day traders trying to profit from short-term price fluctuations in the digital currency market. Most of these traders use lagging technical indicators such as MACD and Bollinger Bands to make decisions.
In contrast, fiat traders in the forex market tend to buy and hold assets for long-term appreciation. If there are many traders who are not very responsive to price movements, the market will be much less volatile.
Additionally, a small number of traders Gambling with Cryptocurrency This is because they believe they can make quick profits without getting caught up in the drama of cryptocurrency price fluctuations. The speculative nature of cryptocurrency traders is fueled by the fact that the markets never ‘sleep’. Markets trade 24/7, allowing retail traders and institutions to react immediately to new information and market conditions. The result of an endless trading environment is high volatility, as high trading volumes can occur in a short period of time.
In addition to technical analysis, speculative traders make many trading decisions based on market sentiment, which makes cryptocurrencies very sensitive to news. When positive news comes out about a major company adopting a particular cryptocurrency, the price of the coin rises.
For example, Tesla disclosed in an SEC filing on February 8, 2021: Purchased $1.5 billion worth of Bitcoin.The price of the coin soared from $38,000 to $46,000 in a matter of hours.
Traders use social media platforms like Twitter and Reddit to gauge market sentiment. Generation Z and millennials make up a significant portion of cryptocurrency traders, and some of them engage in discussions on social media. There are social media sharing buttons that allow information to spread quickly. Twitter’s retweet feature increases the exposure of a post, which can influence the opinions of multiple traders in a short period of time.
One example is the so-called ‘elon effect,’ Cryptocurrency traders are paying close attention to Elon Musk’s tweets about buying cryptocurrencies. Elon Musk’s tweet about Dogecoin on April 15 caused the coin to surge 260%.
Fear of missing out (FOMO)
Fear of Missing Out (FOMO) is the feeling of anxiety that individuals feel when they believe they are not participating in the exciting cryptocurrency price upward trend. It begins when the value of cryptocurrency assets increases and interest in the coin increases. Speculative investors start to feel like they are missing out on potential profits when they get news from social and traditional media.
So they start investing their money in the buzzing digital currency, which drives the price up even higher in a short period of time. At some point, the token price becomes much higher than its real value, creating a bubble. When the bubble bursts, the asset price falls sharply, increasing volatility in both uptrends and downtrends.
One key example of this is Bitcoin’s 2017 price rise from around $1,000 at the start of the year to nearly $20,000 in December.
Low regulation and market maturity
The fact that cryptocurrency use is not restricted by borders is an advantage, but it also encourages a lack of global consensus on how to regulate it. The primary reason for the low regulatory environment in the cryptocurrency sector is its relative youth compared to other financial products.
Bitcoin, the first cryptocurrency, was created in 2009, but people still have questions about it. identity of the creator. By comparison, fiat money as we know it has existed since the collapse of the gold standard during the Great Depression of the 1930s.
Many governments around the world are still unsure of how to regulate cryptocurrencies. Some have banned them, while others have actively encouraged and supported them.
Uncertainty surrounding cryptocurrency regulation impacts investor confidence, triggering immediate price movements in digital currency markets. The moment a regulator in a large economy announces restrictions or rules on cryptocurrencies, it can trigger panic trading in the market. China started in 2021. Suppressing cryptocurrency mining activitiesCiting financial stability reasons, the Bitcoin hash rate has dropped and the cryptocurrency market cap has fallen accordingly.
On the other hand, fiat currencies have a set regulatory framework and therefore have little or no price fluctuations due to regulatory announcements. They are highly predictable and therefore stable, supported by central banks and economic frameworks.
One thing that contributes to the tendency of fiat currencies to be manipulated by large investors is the fact that cryptocurrencies have barely existed. In the digital currency space, you often hear the term ‘whale’. Whales are entities that hold ridiculous amounts of a particular cryptocurrency and can influence the price of that coin through large buy or sell orders.
Lack of market regulation means that large investors can engage in pump and dump scams, artificially inflating the price of a coin, then causing the price to fall when investors sell their coins.
global economic events
Digital currencies tend to react more strongly to global economic events than fiat currencies. When economic instability occurs, such as a financial market crash, investors put their money into cryptocurrencies, which causes their prices to soar.
Geopolitical events, such as trade wars, can also cause volatility in fiat currencies. However, the volatility effect is stronger for cryptocurrency prices. Conflicts in various parts of the world may cause investors to turn to cryptocurrencies as a hedge against the instability of traditional financial markets.
Macroeconomic trends such as inflation and interest rate changes make cryptocurrency prices more volatile. There is a negative correlation between interest rates and cryptocurrency prices. Essentially, the lower the interest rates announced by central banks, the higher the cryptocurrency prices tend to be.
When interest rates are low, people tend to invest in riskier assets such as cryptocurrencies, which can cause price volatility in digital assets. On the other hand, high interest rates can cause investors to withdraw funds from cryptocurrencies, which can cause prices to fall.
Technology Development
Technological advancements in the cryptocurrency space may cause volatility in the digital currency markets.
When investors feel that a particular cryptocurrency will do better in terms of security and efficiency, it increases confidence. If a cryptocurrency project team delays the launch of a new product or technology, investors may see that as a sign of trouble and trigger a huge sell-off.
For example, Ethereum 2.0’s switch from a proof-of-work consensus mechanism to a more efficient proof-of-stake consensus mechanism fueled token price growth.
Another technological development that affects cryptocurrency price volatility is the security of the blockchain or platform. If users discover bugs in the blockchain protocol, hackers can exploit them, which could have a negative impact on the price. One notable example was the 2014 hack of the Mt Gox exchange, which led to heightened Bitcoin volatility after 850,000 Bitcoins were stolen from the platform.
Increase anonymous casino It also highlighted another positive feature of cryptocurrency adoption. As casino gamers have realized that these platforms offer safe and private gambling, the user base of these anonymous casinos has increased, contributing to cryptocurrency price volatility.
Technological advancements such as decentralized finance (DeFi) and non-fungible tokens (NFTs) have created new avenues for increasing cryptocurrency volatility. DeFi systems upgrade traditional financial systems with decentralized protocols, while NFTs represent ownership of real-world assets.
Increasing liquidity in the cryptocurrency market can lead to higher volatility on DeFi platforms due to high trading volume. NFTs can cause cryptocurrency volatility as their price can go up or down depending on how valuable they are.