Factors Leading to High Volatility in Cryptocurrency Market
Extreme volatility in cryptocurrency market was seen in the beginning of 2018 when Bitcoin price dropped down more than 70% after hitting its all time high of almost $20,000 in December, 2017. In just two years the price of cryptocurrency has fluctuated vigorously, creating a sense of uncertainty and instability in the investors. Bitcoin was the first and largest cryptocurrency that experienced a massive growth in merely 12 months. People saw potential in Bitcoin and started investing in it. As the number of users increased, the market became unstable and collapsed. The market capitalization of cryptocurrency dropped from $813 billion to merely $100 billion.
Cryptocurrency is a complex, disruptive and elegant technology that made many people rich. That’s people are attracted to cryptocurrency. Let’s find out how volatility affects cryptocurrency market and why it is considered an integral part of crypto market.
What is Volatility?
Volatility is basically described as the extent to which an asset’s price fluctuates over a certain period of time. Cryptocurrency market is highly volatile as the prices move up and down aggressively.
What are the Factors Resulting in Volatility in Cryptocurrency Market?
Whether you are considering trading cryptocurrency or planning for cryptocurrency exchange Software development, it is important to know that various factors contribute to the highly volatile environment. Here are some of the major factors:
Unlike traditional investments that are mature and time-tested, cryptocurrency market is in its infancy stage and is based on a new technology. It is like what the internet was back in the 1990s, revolutionizing the world.
Possibility of future adoption and disruptions create a perceived value of cryptocurrency in the market, which is based on assumption due to the lack of quantifiable metrics related to the technology. As cryptocurrency hasn’t reached mass adoption yet, its value still depends on hype and assumptions. This is why cryptocurrency has a high risk return trade off.
Liquidity can be defined as the ease to buy and sell assets in an open market. The market that has good volume of transactions and high number of market participants i.e. buyers and sellers, is said to be highly liquid market. Crypto market being in its infant phase is currently facing low liquidity.
A low liquidity market like cryptocurrency is easily affected by the sudden fluctuations in price as a single order can surge or drop the price in just a few seconds. The main reason behind this is the absence of sufficient number of market participants and orders in the market to process a comparatively large order that could move the market. Low liquidity of crypto market leads to volatile price swings.
There are many reasons as to why crypto market is unregulated — complexity and difficulty in regulating an open source and decentralized technology being the major ones. With insufficient regulations, people are not hesitant in performing malicious activities and manipulate the market. These activities can range from coordinated pump and dump schemes to manipulation of trading volume by cryptocurrency exchanges.
Market manipulation leads to instability and high volatility because the large orders placed by such ill-intentioned entities create sharp fluctuations. Given that the crypto market is easily moved by news and sentiments, such activities often lead to volatility.
Speculation is the only driving wheel of this infant market that has no regulations. The value of any asset is dependent on its utility and adoption. For cryptocurrency, speculations work best as there is no possible way to quantify the value of cryptocurrency based on traditional fundamental analysis. Hence the best way to value a coin or a token is to make assumptions on its future use cases, adoption and traction. Since cryptocurrency value is based on speculation, it means high market instability and volatility.
It is important for all investors and traders to understand the concept of volatility before engaging in trading or cryptocurrency exchange Software development. Volatility acts as a boon for high risk takers, while it is a bane for those who avoid taking risks.