Heard people talking about the volatility of crypto markets but don’t know why it is so? In this blog we will simply explain it.
A Simple Explanation Of Why Crypto Markets Are So Volatile
Cryptocurrencies suffer enormous volatility for many reasons. Supply and demand influences their price as much as anything but because many are not yet backed by anything tangible, their value is based on speculation. That leaves them incredibly vulnerable to all kinds of commentary including the media, government and influencers.
The Gold Standard
Tangible assets are physical assets such as real estate, gold or other commodities. Governments used to directly link the value of their currencies to gold, converting paper money to a fixed amount of the precious metal in what was known as the gold standard. Great Britain abandoned that gold standard in 1931 with the US following two years later before completely removing all ties with the value of gold in 1973. Today, all countries use fiat money. That money is legal tender only by order or government legislation. It is not backed by anything tangible. It is simply an understanding and trust in the currency’s value.
The Birth Of Cryptocurrencies
Bitcoin and the alternative cryptocurrencies that followed it were conceived from the distrust of governments’ fiat currencies and their monetary policies. Governments can and do print more money at their discretion and this triggers inflation. That makes the value of that currency dwindle. Just like fiat money, cryptocurrencies have no inherent value – they are not backed by anything. But unlike fiat money, there are open and transparent rules about the total volume of some cryptocurrencies able to be circulated. Bitcoin for instance, has a maximum circulation of 21 million coins. As the total number of bitcoin approaches that figure and its volume approaches saturation, its value is almost certain to rise.
Maximum Supplies Of Different Cryptocurrencies
The availability or scarcity of a coin will inevitably have an effect on its value and potentially its volatility. Some cryptocurrencies have only a finite number of coins to be circulated. As of August, 2022, a little over 19 million of Bitcoin’s 21 million had already been minted with the last expected around 2025. Binance Coin has minted around 161 million of a maximum 200 million. Cardano has around 34 of 45 billion circulating while Ripple has just hit the halfway point of its supply at 50 of 100 billion. Other cryptocurrencies have an unlimited supply but may impose certain limits on the number of coins made available per year. These include Ethereum, Tether, Solana, Dogecoin and Polkadot.
Why Cryptocurrencies Are So Volatile
Demand and supply still play an enormous role in the price of cryptocurrencies, like all other assets. But they also suffer from great volatility because they are relatively new players in the economic landscape and are often not backed by anything tangible. This means their value is based on speculation and trust, leaving them extremely vulnerable to the prevailing winds:
World markets – if Wall St has a bad day, you can be almost certain crypto prices will plummet as panic tends to be extremely contagious.
Government regulations – many governments are still coming to terms with how to treat crypto for tax purposes. Changes in legislation are usually met with a swift market response. Equally, government statements on crypto can have an impact.
Media hype – markets tend to react slowly to positive feedback in mainstream and social media and much more quickly to negative coverage as investors are easily spooked.
Respected influencers – established and respected industry figures can have a big bearing on the price of crypto. For example, Elon Musk was sending the price of crypto soaring or plummeting with a handful of words on Twitter.
The Price Of Bitcoin
Bitcoin is the most valuable cryptocurrency.
It was basically worthless when it was released but within a year had risen to 9c, beginning a breathtaking climb to a high of $68,991 in November, 2021. Although there have been significant crashes along the way that have tested the resolve of the coin’s biggest believers in 2014, 2019 and again in 2022.
The Utility Of Cryptocurrencies
Bitcoin was designed as an alternative currency to fiat money and a means of sending payment anywhere in the world. But many investors have used it to generate wealth, as a store of value and a hedge against inflation, ironically turning to it at a time when traditional markets have also become more volatile. Bitcoin’s success prompted more cryptocurrencies to flood the market with Ethereum the second biggest crypto by volume. Like many other cryptos, Ethereum acts not just as a currency but a utility which is needed to use any of the many transactional platforms on its blockchain. This may include anything from DeFi (decentralized finance) and DAOs (decentralized autonomous organizations) to the trading of NFTs (non-fungible tokens). Despite having another purpose or function, Ethereum’s value and volatility is tied closely to that of Bitcoin’s and it is actually more volatile than its older counterpart.
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