Since its inception, the cryptocurrency market has been volatile, but the last few years have been particularly turbulent for millions of investors worldwide. Many have made millions during market upswings, but many have lost large and small investments during market downturns and bursting bubbles.

Volatility is not a bug for crypto investors who have been in the market for a while – it is a feature, and not just because of the potential for outsized returns. It’s also a benefit because it emphasizes the market’s relatively unique freedom. Because there is no central authority to regulate cryptocurrency markets, they are volatile. As a result, crypto-asset prices can be assumed to more accurately reflect investor sentiment. This gives an idea of what a “pure” market might look like.

Why are cryptocurrencies Volatile?

Cryptocurrency is still a new market

Despite all of the media coverage that cryptocurrencies have received over the years, the market is still insignificant in comparison to fiat currencies and gold. The cryptocurrency market was only worth about $800 billion at its peak. When compared to the whole value of the gold market, which is $7.9 trillion, and the US stock market, which is $28 trillion, this is a drop in the bucket.

Cryptocurrencies are entirely digital

Most cryptocurrencies, such as Bitcoin, are purely digital assets that are not backed by anything tangible, such as a currency or commodity. That is, their price is determined entirely by the laws of supply and demand. Because the supply of many cryptocurrencies, such as Bitcoin, is fixed or predictable, the price is determined by the number of people who want to buy Bitcoin right now.

There is no physical asset backing the value of the major cryptocurrencies, nor are governments enforcing their use as currency. That is, their worth is entirely dependent on faith. If people lose faith in Bitcoin’s ability to hold or rise in value, they will most likely sell. This can cause the price to fall and persuade others to sell as well, resulting in a downward spiral. The inverse can also occur, causing prices to rise and form overinflated price bubbles.

The technology is still developing

Blockchain and other alternative cryptocurrency technologies are still in their infancy. It has only been a decade since the concept of cryptography-based decentralized currencies was published in the Bitcoin whitepaper, so the market will take some time to mature. Nonetheless, many businesses have already embraced blockchain technology and are actively utilizing it for marketing and advertising. AdEx, Steem, and Brave are the most promising projects in the space. Because many customers value blockchain’s transparency and other benefits, investigating this technology could be very beneficial in brand marketing.

When technological challenges, such as the blockchain scalability issue, are not resolved in the timeframe that many expect, they put downward pressure on crypto prices or when their consequences emerge as network congestion and high transaction prices.

On the other hand, technological breakthroughs can have a positive impact. This includes structural advancements like the Bitcoin Lightning Network as well as new popular applications on blockchain platforms like Ethereum. There is also a slew of new cryptocurrencies emerging all the time, all competing for market share from the established ones.

Speculation

Speculation is a major source of volatility in the cryptocurrency market. This involves investors betting on whether the price of various cryptocurrencies will rise or fall by purchasing and selling cryptocurrencies. Indeed, it is the volatility of the cryptocurrency market that attracts speculative traders looking to make big money by predicting the swings.

You can make a fortune if you can predict when the price of Bitcoin will increase and buy right before it does. Similarly, you can profit if you can short sell a cryptocurrency just before it crashes. Many investors are constantly attempting to forecast the cryptocurrency market’s ups and downswings. These speculative bets increase volatility in an already volatile market.

Media

Because cryptocurrency is a small market of digital assets with a lot of speculative activity, the media greatly influences where the prices go. Speculators and investors are always scanning the headlines for the next big news story that will either launch or crash the market. When something does emerge, everyone understands that it’s a race to buy or sell, with the fastest profiting the most and the slowest losing the most. The media’s coverage of the cryptocurrency market has a disproportionate impact on its prices. 

Crypto investor profile

The last element to consider is the average investor profile in the crypto industry. Unlike other industries such as real estate and the stock market, the entry barriers to cryptocurrency trading and investing are extremely low. To invest, you do not need a lawyer, a trading license, or a certain amount of capital. Anyone with a few bucks and access to the internet can begin trading right away.

This is why the cryptocurrency market is the market of choice for millions of inexperienced traders worldwide. Institutional investors, on the other hand, are cautious of the crypto market. Many people believe it is far too risky even to consider going near it, let alone invest significant capital in it.

All of these factors converge together to drive cryptocurrency prices in seemingly random directions at random time intervals. Experts have repeatedly been wrong about predicting the crypto market, and that is unlikely to change anytime soon. However, understanding how quickly the market changes can help you better prepare to market brands that use cryptocurrencies.

The winds of change

“The recent run-up from July lows does not appear to be based on leverage,” says Boggiano, a former regulator, and Wall Street lawyer, in a recent report.

Her conclusion is based on a comparison of the derivative instrument markets and the underlying assets.

“Earlier this year, we saw the futures market trading significantly higher than spot, indicating leverage,” she explains. “Today, the spread between spot and futures or perpetuals is much narrower.”

Indeed, the last time bitcoin broke above $50,000, in mid-February, the average one-month futures premium across exchanges was more than 40% on an annualized basis, according to data from derivatives analytics firm Skew. As bitcoin approaches $50,000 once more, the premium has dropped to 8%.

Another sign of reduced leverage is that funding rates (the cost of holding long positions in perpetual futures) have fallen from 15 basis points per eight hours in February to 3 to 4 basis points per eight hours now.

Calmer Case

Lower systemic leverage implies that the crypto markets, notorious for their wild swings, may become a little tamer.

“Ultimately, it should dampen volatility,” said Hunter Merghart, executive in residence and venture partner at Castle Island Ventures. “A lot of the volatility in the past, in my opinion, was due to auto liquidations” – that is, closing out a trader’s losing bet and selling their collateral.

Auto liquidations can have a cascading effect, amplifying the market moves that triggered them because most perpetual futures are initiated so close to expiration that they are effectively part of the spot market (most exchanges have them roll over every eight hours).

To be clear, in any market, numerous factors can cause price fluctuations, such as money flows.

“We’re seeing a lot of these traditional [investors] now stepping in, especially at the end of the summer here, people are finally ready to play in the sandbox,” says Jason Urban, co-head of trading at Galaxy Digital, a cryptocurrency merchant bank, in another report. “New money coming in chunks and in large quantities is going to increase volatility.”

Regulatory uncertainty, according to Urban, is another wild card that could send prices soaring or tumbling depending on how different agencies rule on various issues. “There is a risk of headline risk in both directions.”

Bigger Picture

During the early-2000s subprime frenzy, big banks and Wall Street firms added layers of leverage behind the scenes by endlessly repackaging home loans into mortgage-backed securities, then into collateralized debt obligations, then into CDO-squareds. We’ve all heard how that story ended.

The growth of decentralized finance (DeFi), in which financing takes place on-chain rather than through centralized platforms and anyone can inspect the open-source code that governs smart contracts, promises to boost transparency in the digital asset markets.