The cryptocurrency market is known for its volatility. Anyone following bitcoin since its inception will know that its price has dropped and also risen dramatically over the years. Although, with hindsight, we can see that there has been an overall steep upward trend, short-term fluctuations have seen many crashes along the way.
There are now many different cryptocurrencies, and all of them experience volatility to a greater or lesser extent. Below are some of the reasons why this is the case.
Supply and demand
Like any asset or commodity, scarcity affects value. The less of something there is available on the market, the more it is generally worth. Many cryptocurrencies exist in a strictly limited amount, with a cap on how many will ever be produced. In theory, the closer to that cap the existing supply gets, so the value should increase. Bitcoin, for instance, is capped at 21 million coins, and 18 million have already been mined. In contrast, ripple XRP has been pre-mined at 100 billion, of which 45 billion are in circulation, which is one of the reasons why it is worth far less.
Cryptocurrencies are presented as an alternative to traditional or fiat currencies, and so their value may rise or fall according to financial and economic uncertainty elsewhere. Worries about inflation or devaluation in the dollar or euro can lead people to invest in crypto instead. That might involve short-term crypto trading in the hope of a quick profit or be seen as a longer-term investment.
News relating to cryptocurrencies can have an immediate effect on their value, as people rush to either buy or sell said currency in response. When ICOs were banned in China in 2017, the price of bitcoin fell from $5000 to $3000 as a result. If the news doesn’t have much widespread, long-lasting significance, the reaction may be brief and, or, localized. When celebrities or major companies are reported as investing in crypto, it can spark a flurry of interest. Still, the stories don’t always make much difference in the long term (except as part of a wider trend).
The legal status of a cryptocurrency can affect its value. Sensible regulation can increase its worth as it encourages new investors and inspires confidence. Equally, however, too much red tape can have a negative effect, as the currency becomes more challenging to trade.
Utility and purpose
In an overcrowded market, a cryptocurrency with a clear and practical application will generally be worth more than just another digital coin. A unique selling point helps any product, and cryptocurrencies designed for a particular purpose may do better than less well-considered ones. Similarly, if a cryptocurrency is widely traded and accepted for everyday transactions, it will likely become more popular than one with limited use.
More than any other currency, crypto is linked to advancing technology. The development of new platforms, applications and security measures will increase demand, while the discovery of weaknesses in the system that leave a coin vulnerable to hacking, or the closure of exchanges, will harm its adoption.
Any of these factors can affect the price of a cryptocurrency. In reality, it is generally a combination of causes that leads to volatility. It should also be remembered that volatility is not necessarily a bad thing, and it is the quality that allows traders to make significant profits. Learning to navigate the markets and read the signs is the key to successful crypto trading.