Crypto markets can be volatile. Since their inception, cryptocurrencies like Bitcoin and Ethereum have seen massive spikes and drops in their value—sometimes even within minutes—and many investors have been left shaking their heads and wondering how such volatility can occur at all.
Crypto volatility is a problem that many traders and investors worry about when they invest in cryptocurrencies. But why do we see swings in the price of Bitcoin and other coins? Why is the crypto market so volatile?
Reasons Behind Cryptocurrency Market Volatility
Crypto or digital currencies are the future of money. They are fast and secure modes of transactions that are not prone to any government control or interference. At the time of writing, the global crypto market cap is $1.2 Trillion, a -39% change from 2021.
Crypto is a high-risk and high-return investment asset class, and trading it requires a lot of analysis and understanding of the underlying technology and market drivers.
Cryptocurrencies are volatile by design. Cryptocurrency markets are highly speculative, and no established regulatory regime exists for their trading. Therefore, cryptocurrencies trade at a more unpredictable rate than stocks and bonds. This unpredictability can be a good thing or a bad thing, depending on an investor’s point of view. For example, if you bought Bitcoin when they were $20 in 2011 and held onto them until they reached $20,000 in 2017, you made a 1,000x return!
On the other hand, if you bought Bitcoin when they were $10,951 in 2018 and sold them at $3,847 in 2019, you lost roughly 70% of your investment. Which begs the question: What factors contribute to crypto price swings?
1. Supply and Demand
To understand the volatility of cryptocurrencies, it’s important to understand how their supply changes as more people buy them and as the mining process continues to produce new coins. When more people want to buy Bitcoin or Ethereum, those coins increase in value because demand has increased. The increased demand and limited supply of coins (there will only be 21 million Bitcoin) create a rise in price because more people want to purchase them than there are available to sell.
As the amount of available coins increases, however, the price of those coins will drop because more people will have the incentive to buy them, and more of them will be willing to sell them. Thus, the market becomes more competitive, and prices may drop as a result.
That’s why cryptocurrencies that have a lot of coins in circulation experience lower prices than cryptocurrencies that don’t have as many coins in circulation. This is because when there are more coins on the market (meaning less demand), the price goes down, and this is one of the reasons Dogecoin is unlikely to ever reach $1. This applies not only to cryptocurrencies but also to stocks and other financial instruments.
2. Speculation and Hype
One of the main factors contributing to crypto price swings is speculation and hype. When a new cryptocurrency launches, it typically experiences an initial spike of excitement as people hear about it for the first time. This often causes people to rush to buy and sell the new coin, which drives up the price to unsustainable levels.
Once people consider the coin overvalued and lose money on it, the hype and speculation die and eventually lead to a price collapse as the bubble bursts. It’s quite common for cryptocurrencies to experience huge spikes and then crashes as a result. Influencers and celebrities also contribute to crypto price swings. For instance, Dogecoin plummeted by 91% after Elon Musk’s SNL appearance in May 2021.
3. Cost of Production
The cost of producing tokens depends on two main factors: the hashrate of the network and the power consumption of the network. In a proof-of-work system like those used in Bitcoin and Ethereum, the miners compete to solve complex mathematical problems in order to get rewarded with new tokens. The more competition there is for mining a certain cryptocurrency, the more difficult it is to mine and the less profitable it is for miners to continue mining it.
Miners could theoretically give up and switch to another cryptocurrency when their mining efforts aren’t paying off anymore. However, this creates short-term volatility in cryptocurrency prices as miners switch to more profitable tokens or hold onto tokens for a longer time. This volatility may even affect the long-term success of certain tokens and cause them to lose market share over time.
Consequently, as mining costs increase, it follows an increased value of the cryptocurrency. Miners won’t continue to mine if the value of the currency they’re mining isn’t high enough to cover their costs. Bitcoin mining is a prime example, with the price adjusting to miners.
4. Competition
Thousands of different cryptocurrencies exist, with new projects and tokens launching every day. However, when competition becomes too intense, it can lead to a decrease in prices by driving down the value of all cryptocurrencies, including Bitcoin and Ethereum.
5. Regulations and Legal Requirements
One factor driving lower cryptocurrency prices is the volatility of governments worldwide that seem to be cracking down on cryptocurrencies. For example, China banned Initial Coin Offerings (ICOs) and froze trading in a number of cryptocurrencies back in September 2017. This caused the price of Bitcoin to drop significantly over a period.
6. Crypto Whales
Crypto whales are large holders of cryptocurrencies. They usually have huge amounts of crypto and money at stake and can move the market significantly by buying or selling large amounts of cryptos. For example, if one person owns the fourth-largest Bitcoin wallet in the world and they decide they want to cash out some of their Bitcoin, this could cause the price of Bitcoin to fluctuate significantly in the short term.
Crypto whales can manipulate crypto prices, no matter the cryptocurrency, be that Bitcoin, Ethereum, Dogecoin, or otherwise.
The Future of Cryptocurrencies
The 2022 bear market has caused many people in the cryptocurrency industry to question the viability of cryptocurrencies as a whole. While some crypto supporters believe that markets will eventually stabilize and that cryptocurrencies will continue to gain value over time, others are more pessimistic about the future for cryptocurrencies as a whole.
Ultimately, only time will tell if cryptocurrencies will ever reach their full potential as a global currency and payment method or whether the technology underlying them will be relegated to a technological dead end.
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