WHAT EXPLAINS VOLATILITY?
"4 years of volatility in the stock market is covered in a month in the crypto markets"
Looking at the overall picture of the past few weeks we can see that Bitcoin’s and other major crypto-currencies’ values have been going up. The trend is obviously bullish. But if you check crypto price charts every day, like we do, you have probably asked yourself the question “What causes a daily 5, 10, 20 percent increase or decrease in a crypto-currency’s value?”
When you compare traditional exchanges to the crypto market, as they say, “four years of volatility in the stock market can be covered in a month of pricing movements in the cryptocurrency markets”.
But why is the crypto market so much more volatile? Not only on a monthly or weekly basis but sometimes on an hourly basis even.
Arthur Linuma, co-founder and president of ISBX, a leading software consulting firm in Los Angeles, wrote a study about it (published on cointelegraph.com). Our article is a short summary of Linuma’s analysis.
So, what explains volatility?
1. No intrinsic value
With crypto-currencies there is no product that is sold, there is no revenue, there are no dividends, and because of this, crypto-currencies’ value is hard to determine. How do we know if it is over- and undervalued? There are no fundamentals to base this information on, so it’s basically exposed to market sentiment, which is significantly influenced by the media. This factor in itself causes high volatility.
2. Lack of regulation
Cryptocurrency regulation is still in its early days, which unfortunately makes market manipulation possible. And that results in unpredictable volatility.
3. Lack of institutional capital
Most institutional investors are still waiting on the sidelines. When institutional capital comes in it has the potential to soften market volatility.
4. Long term vs. short term
If you make long-term investment, then you are probably less concerned about it’s daily price action, so you will probably not trade it. In the case of crypto-currencies, people who vote confidence to them are early adopters of this new financial technology. They are the ones who are changing their portfolio every 10 minutes, who don’t have the discipline to simply buy and hold for the long run. That largely contributes to the panic sells and FOMO buys, causing volatility.
5. Herd mentality
As Arthur Linuma writes: “Crypto is largely a phenomenon of millennials, who distrust government, are early adopters in tech /…/. They also tend to have less disposable income as a result of historically poor job economics, and less time in the workforce. /…/ When the market goes down, this is money that they literally cannot afford to lose, so will dump at the first sign of trouble. Since this is a reactionary behavior, they will generally lose money before getting out of the market. When the market starts surging up, they will buy with the money they don’t have.” The majority of them will react the same way, thus the term herd mentality, and that potentially increases volatility that we see on the weekly, daily or even hourly charts.
When will volatility decrease?
As more regulation is coming in, and a greater diversity of investors is characterizing the crypto market, and as the technology behind transactions is also improving, volatility may decrease. As Arthur Linuma concludes his analysis: “We can also expect a gradual but steady surge in the value of the crypto-currency market as a whole. Just as the stock market has given way to long-term holders, so too will the crypto-currency markets. At the very least, it appears to be something that is going to be here for the long run.”