Cryptocurrencies are and have always been a risky investment due to their constant price fluctuations. By now, everyone knows that volatility is a trademark for these digital assets that comes with both advantages and disadvantages.
Ever since cryptos have emerged as a lucrative form of investment, people have struggled to navigate this volatility and figure out what’s going to happen in the market – making forecasts about how prices are going to evolve for different coins or which projects have the potential to turn into the next big cryptocurrency has become a full-time job for some.
After all these years of speculating and making predictions, one thing has become clear: uncertainty is the only certain thing in crypto. So, whether you win or lose in crypto trading is not just about having the right skills or adequate preparation. It’s also a matter of timing mixed with a little bit of luck.
There’s not much you can do about crypto volatility since it’s an intrinsic feature of this newly-emerged asset class, and most investors wouldn’t even want this to change anyway. But you can and should try to understand where this volatility comes from so you can gain a better understanding of crypto in general and make better-informed trading decisions if you want to dive into this field.
Cryptos are the new kids on the block in the financial system. They started gaining traction almost a decade ago, so even though the whole world has heard about these assets, a lot of people are still not familiar with them. Gold and fiat currencies, on the other hand, have a long history behind them. Gold has been used as means of exchange since ancient times, and government-issued fiat money emerged in the 11th century, although it didn’t become widespread until the 20th century. Both have had enough time to evolve into stable and trustworthy commodities.
Compared to these assets, cryptocurrencies have only been around for an extremely short period of time, so they’re still in the price discovery stage. We can still remember the world without cryptocurrencies, and we can certainly go back to living without them, but it’s difficult to imagine life without fiat money.
As with any innovation, it takes time for digital assets to mature and establish their value and legitimacy so that people can trust and accept them in their lives. This is a normal process, and prices are bound to fluctuate until the growing pains are finally over.
Decentralization is another major characteristic of digital currencies that distinguishes them from traditional assets. Unlike fiat money that is issued and controlled by government bodies, cryptos circumvent all control due to the innovative blockchain technology that underpins them. The entities that support crypto mining and transactions consist of nodes that form a peer-to-peer network.
Their job is to verify and validate transactions in the form of data blocks that are added onto the blockchain, thus ensuring security and immutability.
The fact that cryptos are not reliant on a central authority and the complete lack of regulations that stem from it serves as an incentive for some investors and as a deterrent for others. The use of cryptos without a regulatory framework that could protect investors and their assets leaves room for manipulation, fraud, and scams and therefore contribute to the market’s instability.
Supply and demand
The laws of supply and demand have a major influence on the price of all assets, and cryptocurrencies make no exception. A lot of crypto projects, such as Bitcoin or Litecoin, have a pre-determined maximum supply. For Bitcoin, the max cap was established at 21 million, while Litecoin draws the line at 84 million.
Bitcoin’s value has fluctuated over the course of time and continues to oscillate, as can be easily observed by consulting the Bitcoin price chart on any exchange platform.
As people continue to mine Bitcoin and the supply diminishes, it’s likely that the demand to increase, which will drive the prices upwards. Some investors may decide to hold on to their coins, and that will also have a major impact on the supply-demand dynamics, leading to more volatility.
Just like fiat currencies, cryptos are not backed by anything, so they have no intrinsic value. Their value comes from people’s beliefs that they’re actually worth something, and that can be an extremely feeble foundation to build upon. If for one reason or another, a large number of people change their minds about the value of a certain digital currency, as has happened in the past, the crypto will suffer a major decline and even be completely wiped off.
This is an extreme scenario, but one that can actually happen nonetheless. Marketing sentiment can change in time due to a series of factors, and no one can tell for sure which crypto will be accepted and which will fall out of grace.
Any information that is spread by mainstream media ends up reaching a large number of people, influencing their decisions and actions. For example, when Tesla announced that they would stop accepting Bitcoins as a form of payment for their vehicles, the coin’s price suddenly dropped.
Then again, when Elon Musk showed his support for Dogecoin in a couple of tweets, the crypto gained immense popularity, and its price immediately surged by more than 50%.
The problem with the media is that you can never be sure of the accuracy of the information they provide. One outlet can share a piece of news that is favorable to a certain crypto project, and another one can provide contradictory evidence, leading people to believe the exact opposite.
Therefore, crypto prices may also vary based on the news and information shared on social networks, websites, in newspapers and magazines, or through other media channels.
While crypto volatility might recede in the future as the market matures, prices will always fluctuate to some degree. However, that shouldn’t be regarded as a drawback, given the high return potential that volatility brings to the table.