Why is Cryptocurrency Volatile Compared To Other Investment Vehicles?

Why is Cryptocurrency Volatile

Welcome back to the Tribe! In this post we are going to go over a common question, why is cryptocurrency volatile?

Nothing should be considered investment or financial advice. Enjoy the ride!

Why is Cryptocurrency Volatile Compared to Fiat Money?

The growth of cryptocurrencies has sparked controversy over the sustainability of fiat money, such as the US Dollar, Chinese Yen, or the Indian Rupee, which are all mostly controlled by their respective governments.

Due to this, virtual currency is quickly growing in popularity all over the globe. Although, it is not able to completely substitute fiat currency, which is still the most frequently used method of exchange.

The purpose of this article is to explain how bitcoin compares to fiat, and why cryptocurrency is more volatile than fiat in general.

Although, before we go much further, we need to know how both currencies work and what distinguishes them.

Let’s get this ball rolling, shall we?

What Is Cryptocurrency and How Does It Work?

Cryptocurrency is a relatively new medium of exchange that is protected by cryptography and verifiable by a thing called blockchain

The main advantage is that It’s practically impossible to spoof or double-spend any crypto due to cryptography like a digital signature algorithm.

In general, crypto may be used to buy things and pay for services just like fiat money! Many businesses have even launched their own cryptocurrency. Consider them casino chips that can be exchanged for fiat currency and used to buy and sell products and services.

There is no need for a central authority because all cryptocurrency transactions are recorded on a decentralized internet ledger that is transparent to everyone at all times. Presently, there are over 10,000 different cryptocurrencies in existence, according to CoinMarketCap.com, a market research website.

What is the Difference Between Fiat and Cryptocurrency?

To start, fiat is typically controlled by a central authority like a government while cryptocurrency is considerably controlled by a community.

This “control” can be through mining the coin or by staking! Every coin on the market is different, but the main idea is that digital assets are supposed to be decentralized and immutable. This practically means that you can never manually create more of an asset. Meanwhile, countries can typically print more fiat as they see fit increasing supply.

Due this difference, crypto is naturally anti-inflation, and could be considered more secure then traditional fiat due to the lack of any central power holding leverage over the market.

With that knowledge, lets move onto the volatility aspect.

Why Is Cryptocurrency Volatile

Regardless of the decentralization, there are still some issues that are currently lending to an unstable market. Here are four of them:

The Cryptocurrency Market Is Expanding:

Comparing the magnitude of the bitcoin marketplace to the size of fiat is daunting.

For example, crypto as a whole in 2021 stretched itself over the 2 trillion dollar market level and reached just shy of the 3 trillion mark several times. Compare that to gold alone which has a market cap of over 11 trillion, you can see there is plenty of room to grow.

In addition, with said growth there will be considerable amount of volatility naturally as the market continues to mature and big money moves in and out of the market taking profits as it does.

Cryptocurrency Is Mostly Comprised Of Digital Assets:

Because most cryptocurrencies, such as BTC, ETH, Dogecoin, and others, are essentially electronic assets, which denotes they aren’t preserved or substantiated by a currency or equity, supply and demand play a big role in determining their pricing.

Furthermore, since cryptocurrencies such as Bitcoin and Ethereum are fixed assets, their prices are initially established by their supply. There is no other asset to preserve the valuation of BTC, ETH, or even governments as a monetary foundation if the closure happens again. This also indicates that their value is completely determined by their willingness to take risks in an immature market.

Although, as the utility of assets grows over time there will be more stability in the market and less risk will be needed to hold these assets.

Cryptocurrencies Are Still A High-Risk Investment:

Even though they are high-risk currencies, investors’ profits will be based mostly on market movements.

Cryptocurrency trading is mostly uncontrolled. Unlike the US dollar, the coins are not guaranteed by a government or central bank. The Securities and Exchange Commission of the United States does not yet regulate the purchase and sale of this type of currency.

Due to this, there will be a lot of money flowing in and out of the market in very short time frames. This is not a good thing, and it does not represent a mature marketplace either.

In the traditional marketplace, the higher the risk then the higher the expected return should be. Crypto is no different, but with high risk comes uncertainty. This lends to investors wanting to quickly liquidate at the sign of any sufficient market moves.

Lack Of Legislation

The last reason for the increased volatility in the crypto space is the lack of legislation.

Mainly in the US, China, and Russia. Over the years, these countries have continually flip flopped on the space. Some claiming that certain assets were securities, others completely banning the assets for a few years, and some just out right refusing to add concrete laws or clarification like the SEC.

Due to this, there is a drastic increase in uncertainty on the lifetime of some assets. Ripple is a great example of this and how the lack of transparency around the asset class can impact market values.