The Agony and the Ecstasy: Cryptocurrency Volatility and Where It Comes From
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The story borders on cliché – your Bitcoin holdings are worth $1,000 when you go to bed, soar to $2,000 overnight, and are worth $500 when you wake up. What’s the deal with that?
Although it has a market cap of some $189 billion, Bitcoin behaves like a small-cap stock with a price that moves up and down in response to market perception and market reality. The day traders buy and sell their crypto as often as they think it’s profitable to do so, and the famous HODL camp clutches their BTC on the expectation that its value will not only stabilize, but soar in the long term.
So what causes the fluctuations in this value that spells agony and ecstasy for the crypto community? Well, there’s no single cause.
It’s difficult to identify a cryptocurrency’s intrinsic value.
It’s hard for something to hold conventional value when it doesn’t sell a product, earn revenue, or drive employment. Cryptocurrency on its own does none of these things. It almost universally doesn’t return a dividend, and only a fraction of a currency’s total value goes toward its further evolution and development.
It gets easier to identify a value when you examine specific use cases. If we were to implement crypto in the $689 billion remittance market and were hypothetically able to slash transaction fees by 10%, then its intrinsic value would be nearly $70 billion. But this technology has traits that transcend the monetary – it enables a certain degree of anonymity and is censorship resistant. These are valuable features, but how do you price them?
Crypto prices fluctuate because it’s hard to determine what a given currency is worth. We can’t confidently identify when it’s overbought or undersold, we can’t assert when it’s a good value or when it’s overpriced. With these hard economic identifiers missing, that means perceived value is the name of the game.
But perceived value comes with its own set of problems.
Perceived value changes as easily as perception does.
Media and current events play a fundamental role in driving a cryptocurrency price up or down. I don’t think news outlets try to manipulate prices intentionally, but they do seem to write more articles about Bitcoin when the price goes up. Good news for Bitcoin is good news for Bitcoin holders. Suppose Amazon decided to accept payments in Bitcoin – the resulting news coverage would inevitably lead some people to buy more Bitcoin, which drives its price up. Those who already held this digital asset would get to watch the value of their holdings rise in response.
Consider the fact that Elon Musk just tweeted the word “Ethereum” on April 29. ETH was trading around $153 at the time of his tweet, and it finished the day with a high of $174.
Beyond news events, cryptocurrencies fluctuate against ordinary fiat currencies because of their perceived store of value versus that of fiat currency. Bitcoin is often referred to as “digital gold” because of its similar limited property: just as there is a finite amount of gold in the world, there will only ever be 21 million BTC.
Fiat currency works completely differently. Governments are able to manage their supplies of conventional money as they see fit in order to adjust economic indicators like inflation or employment. They can make more money when they need it. But there will only ever be so much Bitcoin.
There’s a lack of regulatory oversight.
Ten years after the invention of cryptocurrency technology, there’s still no consensus on how this development should be regulated or how the world’s laws should interact with it. Smart contracts are independent automated actors on the blockchain, so they pose interesting regulatory questions around who owns them and who’s responsible for them. But laws are beginning to align more and more, and it’s interesting that there’s no single place where mining is regulated.
Even if certain laws did criminalize cryptocurrency, that doesn’t come close to shutting it down or taking the network offline. It just makes it illegal. But this technology is independent and unstoppable – its whole purpose is to be resilient against attack.
Limited regulation means this sector can be subject to market manipulation, and this easily scares away many of the world’s institutional investors that would otherwise lend credibility to this gray space. Without mechanisms protecting them from bad actors, many mainstream banks would rather avoid the crypto game entirely.
There’s a consistent short-term mentality.
Cryptocurrency isn’t a retirement fund, and it’s largely inaccessible to conventional retail brokers and financial advisors. This excludes whole categories of practiced investors who are more inclined to let an investment ride.
This means the crypto space is by and large dominated by early adopters who don’t fear technology, but instead embrace it. They don’t see newfangled exchanges and wallet software as a meaningful obstacle on their way to trading. They’re happy to monitor a real-time price feed for the sake of making a trade at exactly the right perceived moment. This kind of person is generally not going to make a buy and sit on it, so constant trading activity causes constant price changes.
Crypto prices reflect a uniquely free market that operates whether or not certain governments permit it. They’re based on the usual drivers of supply and demand that see the associated assets priced like any other commodity in limited supply. Every normal commodity priced on the free market is volatile, so it’d be strange if crypto weren’t volatile.
Crypto volatility is bound to iron itself out as the market matures. Despite 10 years of trading history and thousands of disparate currencies being mined today, cryptocurrency is still in its reactive infancy. There are lingering questions about what kind of value it holds, and public perception plays a big role in identifying that value. There’s no universal regulation that identifies how it should be bought and sold, so people are largely free to buy and sell as they see fit. This all comes together to create an environment where the price is reactive as opposed to predictable.
Whatever your own crypto holdings were worth when you started reading this story, the number has surely changed since then.
Philip Salter, head of mining operations, Genesis Mining