Volatility: The Chasm Between Crypto And Mass Adoption?
By Reuben Machinga
Go to your favourite source of market data, candlestick graphs preferably, and look at the price fluctuations of common cryptocurrencies. Now, contrast those with other asset classes like stocks, bonds, or traded foreign currency pairs. The former are much more volatile than the latter, right? In other words, volatility, in our case, the marked change in the price of an asset, is almost a defining characteristic of cryptocurrency markets.
Why are crypto markets so volatile? Could volatility explain why we haven’t seen mass adoption of cryptocurrency? Finally, is there a remedy that reduces volatility?
Why the volatility?
Writing over at Cointelegraph, Arthur Iinuma identified the lack of intrinsic value as one of the reasons behind the dramatic price fluctuations seen in cryptocurrency markets. Unlike other assets, the majority of cryptocurrencies are not backed by anything. This makes analysis incredibly difficult.
For the sake of comparison, let’s attempt a rudimentary analysis of the price of aluminium. On the 22nd of June 2018, the price of aluminium was US$2,165 on the London Metal Exchange. We can debate if this metal is under or overvalued. Perhaps the increasing fuel efficiency standards in the EU will force automakers to use less steel in their vehicles’ chassis in favour of aluminium and, as a result, we can expect the price of the latter to go up. (Steel ladder frame chassis are markedly heavier than aluminium monocoque ones; therefore, using the latter would make vehicles more fuel-efficient) Alternatively, we could argue that a slowdown in the global economy, sometime in the near future, will lead to less demand for new cars. Consequently, automakers will be holding excess raw materials and we can, as a result of the weakening demand, expect aluminium prices to go down.
Such an analysis, as rudimentary as it may be, would prove difficult to conduct for most cryptocurrencies. What ‘real’ economic activity could we reasonably ascribe to the price movements we see in crypto markets? I would be hard pressed to find a few.
There are of course many other reasons that explain cryptocurrency price volatility, however the lack of intrinsic value is key; it bears great explanatory force.
Volatility: the chasm before mass adoption?
We expect money to fulfil several functions. One of them is being a reliable mechanism of storing and transferring value. Volatility, then, robs from cryptocurrency its ability to fulfil this function.
Steve Wozniak, the Apple co-founder, heaped a great deal of praise on Bitcoin. He went as far as suggesting that the leading cryptocurrency ought to be the global currency. While I am partial both to him and to how he justifies his assertion, I found it telling that he ended up selling all of Bitcoins, except one. He didn’t want to be “…one of those people that watches it, watches it, and cares about the number.” (CNBC) The mathematical foundations of Bitcoin are solid. Only a limited number of them will be issued. However, this rigidity in issuance hasn’t stopped wild fluctuations. It would also not come as a surprise that I don’t quite share the same view about gold as ‘The Woz’ does. Even though we don’t know exactly how much gold there is in the world, it has proved, consistently, to be a reliable store of value.
We shouldn’t throw away the baby with the bathwater, however. Distributed ledger technology, which powers cryptocurrencies like Bitcoin, is an incredibly powerful tool. It makes the latter half of that obligation we place upon money much easier. Transferring crypto funds from one wallet to another is fast, reliable, and easy.
Too much market volatility also dissuades participation from some segments of the mass market. Many institutional investors and retail investors who are not comfortable with playing on the ‘bleeding’ edge would not revel at the thought of investing funds in crypto because of it.
Resolution?
Clearly cryptocurrencies are an important technological advancement that we cannot afford to relegate to the dustbin of history. The lack of intrinsic value is not an insurmountable challenge. To solve that challenge, I feel we must look to one of the oldest and most trusted commodities: gold. Merging the two, we get the consistent value of gold and the ease of cryptocurrency.
But why not go the route that Tether (USDT) has gone? There are two things to be said about this. Fiat currency is itself without intrinsic value. Many are now aware that central banks have great discretionary power over the creation of fiat money. Wozniak was quite right in saying that things such as ‘quantitative easing’ and other monetary interventions by the financial authorities distort the value of money. Is $100 worth $100 when the Federal Reserve creates another $1 billion? The story of the US dollar losing 98% of its value abounds on the Internet. Secondly, and specifically to Tether, accountability proves to be a challenge. Many people question whether each Tether is really backed up by a corresponding US dollar. Auditing has proved to be a pesky challenge for them. Pesky relationships with auditors aside, it is the difficult relationship with traditional financial institutions that proves to be the greatest hurdle. Not all banks, correspondent banks, central banks, and financial regulatory authorities are particularly keen on cryptocurrencies.
This solidifies in my mind the role gold plays to resolve these challenges. As I mentioned before, gold has held its value remarkably well over time. The graph below shows how the price of gold in US dollars has stayed within a US$400 range.
Compare this to the one-week volatility seen in Bitcoin displayed on the graph below. Within a week, Bitcoin lost almost $1,000 in value.
The question becomes just how the value and stability of gold can be tied to cryptocurrency. At Goldma, we have decided to do that by issuing the GMA token. Token holders receive royalty payments derived from the profits earned on Goldma’s gold mining operations. Because there is a quarterly pay out to token holders, something very loosely akin to bonds, there is a way of quantitatively calculating the benefit of being one. Value, then, ceases to be completely speculative and becomes more rational. This should speak to more considered members of our society.
Another way is the one chosen by Flashmoni. They opt to have a direct link between gold and their cryptocurrency token. It’s directly backed by gold stored in specified places and audited by a separate company.
Both options should introduce stability into cryptocurrency. With stability in our sails, we may begin to cross that chasm.
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