The Problem of Cryptocurrency Volatility

A cryptocurrency is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets. Cryptocurrencies use decentralized control as opposed to central banking systems. The decentralized control of each cryptocurrency works through distributed ledger technology, typically a blockchain, that serves as a public financial transaction database.

Cryptocurrency market and its volatility

Cryptocurrency is becoming a wide spread topic nowadays that has expanded to a more diverse audience compared to the limited early stage adopters that valued privacy, globalization and decentralization above all else. The technology underlying cryptocurrencies have powerful applications in various sectors ranging from healthcare to media.

The benefits that cryptocurrencies can bring has sparked interest in the mainstream market — with regards to both technological advancement and popularity. Investors flooded to achieve gains when the value of Bitcoin increased in price exponentially. There was a massive gain potential from trading digital currencies, given the semi-regulated market, and many took advantage of it in a speculative way. However, the extreme speculative nature of crypto market created the recent digital currencies downturn that many didn’t expect.

Triggered by the plunge in Bitcoin’s price change due to various reasons (such as ongoing ETF approval from SEC), according to the Bitcoin (BTC) Volatility Index as of Dec. 9, volatility levels on the BTC-USD market have risen threefold on the month.

Handling volatility is nothing new for institutionalized investors. Financial derivatives, stocks, bonds or forex are all prone to swings, but the problem is that cryptocurrency volatility is off the charts. Investors in cryptocurrency are often new to the game and have not experienced the range of swings before — watching their money both grow, and shrink substantially by the hour can prove as being challenging even for the strongest at heart.

Many would ask why is this asset class more volatile than any other liquid asset in the market? Here there are some reasons listed by Cointelegraph:

1. No intrinsic value — Without any concrete fundamentals to base the price, value, supply and demand, we can only rely on market sentiment.
2. Lack of regulatory oversight — With governments trying to understand the industry, regulation is still in its early days. This allows for market manipulation which, in turn, introduces volatility, and discourages institutional investment.
3. Lack of institutional capital — Most of the institutional capital is still on the sidelines, lacking a large trading desk that has the potential to introduce efficiency and soften market volatility, or a mutual fund buying on behalf of their investors for the long term.
4. Thin order books — Most of the tradable supply is not on an exchange order book but in off-exchange wallets. A large market order can eat into an exchanges order book on the way up or down, causing “slippage”. Because of the capacity for large traders to move the market in either direction and employ tactics to encourage this, volatility goes up.
5. Long term vs. short term — Current crypto market is formed by speculators mostly, that are focusing on earning the sell-buy margins.
6. Herd mentality — When the market goes down, the traders will dump the asset at the first sign of trouble. Since this is a reactionary behavior, they will generally lose money before getting out of the market. When the market starts surging up, they will buy with the money they don’t have creating some sort of synergistic effect.

Stablecoins growth in adoption

Stablecoins have showed massive growth in adoption in the past several months, as a solution for the current market need for stability.

A stablecoin is a cryptocurrency designed to minimize the effects of price volatility. Stablecoins are used as stores of value or hedge, as well as in other use cases where volatile cryptocurrencies may be less desirable.

According to Diar, a large increase of 1032% in on-chain transactions with stablecoins took place in November vs. September breaching the $2.3Bn mark at the close of November.

Looking at the trend, we could anticipate a massive surge in stablecoin creation moving forward but the question is: how stable are the stablecoins? It is essential that users understand the core of stablecoins and the great benefits that this could bring if it’s pegged to the right value and backed by the right asset.

Conclusion

The cryptocurrency market has felt the ill effects of an unstable market, as many investors continue to exit the market due to fear and uncertainty about how low the market may drop. Perhaps the changes in the cryptocurrency market will force investors (speculators or hedgers) to study the market and understand the cycles, creating a more mature and safer ecosystem that everyone could benefit from.

But most importantly is to create trust in crypto world, advancing the technology and community engagement to its full potential while building the public confidence necessary for mainstream adoption. Stablecoins will help in this process.