When Beijing banned crypto outright in September 2021, crypto prices fell hard and fast. The downside didn’t last, but international exchanges scrambled to drop Chinese users now that a legal gap had been patched. This is just one of the myriad reasons cryptocurrency experiences volatility.
Understanding crypto volatility can be tricky, but there are a handful of broad reasons you can look at to determine why a particular cryptocurrency is falling. From there, you can make an educated assessment about its future.
TL;DR
- Crypto tends to have stronger, more frequent volatility compared to more traditional assets. Still, the stock market carries its own risk, especially during times of economic distress (such as during the pandemic).
- Many altcoins follow bitcoin‘s fluctuations.
- Bad news, security concerns, regulation, and perceived value can impact cryptocurrency values.
- Whales (aka people who hold a large number of coins of a particular cryptocurrency) also cause volatility within a specific asset.
- Much like the CBOE Volatility Index, the Crypto Volatility Index tracks volatility for bitcoin and Ether.
Crypto has a record of volatility, but it’s not alone
By mid-November 2020, 29% of S&P 500 companies had more volatility than bitcoin (BTC) so far this year, according to VanEck. Of course, the stock market crash in February of that year made mainstream assets much more prone to value changes.
All types of investments carry risk, but experts do agree that crypto experiences volatility more often and at higher rates. It’s a speculative asset, which means it has a limited history and price fluctuations. Still, crypto is an emerging market that’s creating a space for itself in the world, with countries legalizing it and companies integrating blockchain technology into their payment processes.
Is altcoin volatility based on bitcoin’s value?
There are thousands of cryptocurrencies, but bitcoin is the original. That’s why most other coins are called altcoinsor alternative cryptocurrencies. In many cases, these altcoins are correlated to bitcoin’s price. This is because:
- BTC is the original cryptocurrency.
- Despite its energy-guzzling nature, the Bitcoin blockchain’s proof-of-work (PoW) consensus mechanism is extremely secure thanks to more than 1 million unique miners across the world.
- To many investors, bitcoin is to cryptocurrency what the USD is to fiat: a reserve currency.
In these cases, when Bitcoin is volatile, so is a chunk of the market. However, many cryptocurrencies experience their own volatility, like when Litecoin fell following the publication of a fake press release stating Walmart would be accepting payment with LTC.
Key reasons for crypto volatility
Bad news: Cryptocurrency values are sensitive to news. They go up when news is good and decrease at the sight of bad news. Government regulation, geopolitical news, and illicit activity are just a few types of stories you might encounter.
However, the news is not always as straightforward as good vs. bad. El Salvador made bitcoin a legal tender in early September. Despite the fact that a new country was making crypto mainstream, bitcoin values fell. Many investors worried that El Salvador’s troubled economy could burden the value of BTC.
Whales: For many cryptocurrencies, one or a few investors hold a huge chunk of coins. These people are called whales.
Whales who hold their positions stagnant for a long time can make the market volatile since it reduces the asset’s liquidity. Meanwhile, whales who sell a bunch of their crypto at once can cause market value to shrink.
Perceived value: Think of the UK’s perceived gas shortage in September that led to panic buying and, ultimately, a real gas shortage. When cryptocurrency traders perceive crypto values as lower, they sellthus decreasing the price.
Much like gold, bitcoin and other cryptocurrencies tend to be measured against fiat currency (like the US Dollar). If there’s uncertainty about the asset’s future value, the current value can go down.
Cybersecurity concerns: Blockchain technology uses decentralized consensus mechanisms to maintain security for buyers and sellers. Bitcoin uses a PoW (proof-of-work) mechanism, but that’s not the only option. For Ether (ETH), there’s the PoS (proof-of-stake) mechanism. Crypto assets like Bitshares use a DPoS (delegated proof-of-stake) mechanism.
When there are breaches in security, cryptocurrencies have to make the public aware. It’s a decentralized network, after allso it takes the public to resolve the issue.
Tax treatment and regulations: The U.S. has hinted at more regulations for cryptocurrency. Currently, crypto gets taxed as a property asset, which means traders have to record the coin’s market value at the time of each transaction. They also have to pay capital gains taxes.
Fears of regulation negatively impacting cryptocurrency are one of the many reasons why cryptocurrencies are so volatile.
What to know about the crypto volatility index
In the stock market, we have the CBOE Volatility Index (VIX) to measure the market’s projected volatility. According to the CBOE website, the benchmark index is a “30-day expected volatility of the U.S. stock market,” derived from real-time, mid-quote prices of S&P 500 call and put options.
Meanwhile, the crypto world has its own volatility index. CVI is a decentralized crypto volatility index for bitcoin and Ether “that allows users to hedge themselves against market volatility and impermanent loss.” It’s built on the Ethereum blockchain and Polygon tool and basically brings the market fear index to the crypto market.
CVI is not a given, but it’s a good example of volatility within the market. By knowing the different types of events that can cause volatility for a particular cryptocurrency, an investor can use the index to understand how and why BTC and ETH do what they do.
Bottom line
A German hamster named Mr. Goxx (after the since-bankrupt bitcoin exchange called Mt. Gox) is currently buying and selling crypto in its own high-tech cage. With 16% returns in three months, Mr. Goxx has managed to outpace bitcoin, the S&P 500, and Berkshire Hathaway (NYSE:BRK.B).
Retail investors who enter the crypto trading world may not always be so lucky thanks to high volatility. Knowing what causes crypto volatility is the first step in maneuvering the inevitable ups and downs.