#Business15 Jul

The Cryptocurrency User’s Guide To Volatility

Alisa Tkach

And why volatility is attractive?

And why volatility is attractive?

It is impossible to partake in the crypto market without having to confront the term “volatility”, which has been recognized as one of the cornerstones of the entire decentralized asset industry alongside its founding technologies based on the blockchain. The state of the cryptocurrency market has always been determined by its profitability, which forms the backbone of its capitalization and liquidity thanks to investor sentiment and appeal. But the profitability of separate assets on the crypto market, and the leading ones especially, has always been directly and proportionally related to their volatility, which makes up their ability to capitalize on gains.

Stability is not a quality sought by cryptocurrency investors, as stablecoins have proven by their mediocre popularity and attractiveness as trading assets. Such coins that tether their value to stable commodities or currencies are regarded more as value-saving assets, rather than value-accumulating assets. That is why coins with high volatility, such as Bitcoin, Ethereum, Ripple, or even memecoins like Doge, have been in a league of their own ever since their inception.

The volatility of the crypto market is incomparable with that of traditional markets due to the inherent qualities of the digital assets industry, which is highly unpredictable, unregulated, unbound by international boundaries, and heavily reliant on the fluctuations of price dynamics that abide by the law of supply and demand. In fact, the principal law of supply and demand in crypto-economics is guided by the same principles as those on the traditional markets – geopolitical situations, news backgrounds, announcements, regional regulations, partnerships, capitalization gains, even rumors, but all on a highly exaggerated scale that is propagated by the extensive use of social media.

What Is Volatility

Volatility is the change in prices of assets over time in relation to historically established levels. Volatility can also relate to entire markets, or individual assets like cryptocurrencies, stocks, bonds, commodities, or currencies like fiat.

One of the most prominent illustrations of the impact of volatility can be traced in the Forex market, where exchange rates fluctuate up and down, thus resulting in price changes of currency pairs that traders take advantage of by selling at upper intervals.

How Top Measure Volatility

Volatility can be measured using a variety of approaches and complicated formulae that are applied to historical data to extract not only current volatility figures, but also predict possible movements in the future. The given approaches are instrumental in the prediction of price movements and form the basis of technical analysis, which is vital for any trading activities.

Apart from basic volatility, which is calculated on a daily, or even hourly basis by comparing historical price data from given time intervals, there are also other types of volatility, namely:

  • Historical volatility, which is the analysis of the standard deviation of the annualized daily returns of the underlying asset over time that can be extended to any frame required for determining values or market dynamics.
  • Implied volatility, which is the representation in figures of what the market expects at a certain time in the future. This type of volatility is part of technical analysis and is calculated based on historical data.
  • Market volatility, which represents the price velocity of separate assets like commodities, Forex pairs, stocks and others.

Most types of volatility are calculated based on a simple approach of finding the mean of a selected data set. Once the range has been selected, the difference between each value and the mean is calculated. The deviations are then squared and added. The sum of the squared deviations is then divided by the number of data values to obtain an average.

Everything depends on the number of values in the selected data set and the timeframe selected, which will determine the number of values.

Volatility In Traditional And Cryptocurrency Markets

Cryptocurrency markets are considerably more volatile than traditional markets due to the dynamic nature of the digital industry. With numerous new developments in technology and the abundance of news feeds, every event in the industry exacerbates the demand and supply curve’s fluctuations based on the experience of industry participants received in early 2017-2018, when the ICO boom resulted in both immense gains and catastrophic losses.

With fear governing most investors on the crypto market, and given their ability to make near-instant entry or exit, the prices of crypto assets are governed by adoption and regulation affecting the industry. News developments and speculation fuel price instability, which, unlike on traditional markets, is rampant on the crypto market due to a lack of concrete international regulation of the industry and the absence of real-world asset backing in the form of commodities, like gold, that would have added stability.

Day traders on the crypto market are largely responsible for both pumps and dumps, cleverly leveraging news backgrounds to their benefit and ushering droves of smaller market participants.

Current State of Volatility

The impact of volatility as a market phenomenon can best be illustrated against the backdrop of a stimulant that usually results in it. The Covid-19 pandemic is one such striking example of a factor that has spurred massive volatility across not only the crypto, but all markets together taken.

As of 2021, the global financial market has experienced colossal levels of volatility due to the pandemic, which has literally shattered the traditional mode of operations of supply chains and ruined thousands of businesses by disrupting international communication, cooperation and economic interdependence. The largest declines can be traced to the three major stock indexes – the Dow Jones, NASDAQ, and the S&P 500. If 2021 figures are to be considered, the declines on all three indices were 37.1%, 30.1%, and 31.9%, respectively. Such figures can be compared to a decrease of more than $10 trillion in monetary terms. That accounts for more than 45% of all gross domestic product (GDP) in 2019 in the United States alone.

But there seems to have been an inverse relationship between the impact on traditional markets and the dynamics of the crypto market, as indicated by historical price data. The records of Bitcoin prices, which act as an unofficial benchmark for the entire cryptocurrency market, indicate that the king of cryptocurrencies has risen from a low of $7,000 in March of 2020 at the outbreak of the pandemic, to almost $65,000 by April of 2021. The almost 970% increase of the price of Bitcoin instantly spurred the growth of the entire crypto market, injective massive amounts of liquidity that stimulated the development of new protocols and projects. Such volatility made Bitcoin the most volatile asset in history, outpacing gold.

Indeed, the inverse relationship can be attributed to volatility, as the exchange rates of fiat currencies around the world started depreciating with the introduction of lockdowns and shrinking GDPs. As national currencies depreciated, people started looking for ways to retain the value of their savings. Apart from real estate and gold, cryptocurrencies became one such haven of value-saving as the introduction of profitable Decentralized Finance protocols, staking options and liquidity pools allowed for leveraging such options as passive income generation.

The inverse relationship can be traced even further up the historical charts to the end of May of 2021, when the stock indices started recovering along with the global economy. The rise in traditional indexes coincided with a crash of Bitcoin to around $36,000 by early June of 2021.

Conclusion

Volatility makes assets profitable. Stability is not a virtue of the crypto market. Attracting investors and traders seeking quick profits, the volatility of crypto assets outstrips that of any traditional asset.

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