A simple definition of volatility refers to the ‘liability to change rapidly and unpredictably, especially for the worse.’ When you invest in cryptocurrency, this term would apply this to a digital asset. An asset’s nominal value is liable to change unpredictably.
Why are crypto markets volatile?
Most investment in cryptocurrency is done through speculation, with seasoned traders using market patterns to inform their decisions. Other things can impact market volatility such as when an exchange is hacked, endorsements change, or if vulnerabilities in a technology are exposed. With cryptomarkets allowing people to trade around the clock, markets are in fluctuation 24/7.
Liquidity can be inextricably tied with market volatility. In the crypto community, liquidating an asset means transferring the cryptocurrency back into Fiat currency. (Fiat refers to a national currency, i.e. sterling, dollar.) Though, the available liquidity will be dependent on the markets and exchanges.
When a trader sets a price that they will buy or sell an asset at, it’s registered in the order book. The trade will then be completed once another buyer/seller has matched the first trader’s order. Overall, if liquidity is low then the order book will be less stacked. Consequently, the price of digital assets will be affected as the trading volume goes down in tandem. This has a knock on effect for market volatility, since no one trader can ever be certain when liquidity will rise or fall.
No regulation and increasing schemes
Since we are still relatively in the infancy of cryptocurrency, there isn’t a great deal of regulation in place. A lack of regulation naturally leads to easy market manipulation through schemes and scams, causing an increase in volatility. An example of schemes that cause market volatility is a ‘pump and dump’ strategy that falsely drive prices up. Scammers achieve this by purchasing a lot of the targeted token, before selling them off for a lot of profit. Then the assets price will drop; because it was only artificially inflated and never had any organic growth. This is just one form of market manipulation that can lead to volatility.
Market volatility is an inherent factor to consider when investing in cryptocurrency. Before making any decisions, do your market research and keep on top of the latest news. You need to respond in a rational and measured way to changes in the market, rather than having an emotional response that is often driven by a fear of missing out. Never invest more than you can afford to lose and keep an eye out for cryptocurrency scams.
If you want to know more about cryptocurrency trading, read our definitive series!
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.