It is abundantly clear that if you are a risk-averse or highly cautious investor it is likely that investing in cryptocurrencies is not the most suitable of opportunities to put your money into. Sites such as mywealthandinvestment focus on investment ideas, and are often talking about the crypto market's volatility. They discuss issues around the most well-known of the currencies, Bitcoin, for instance.
Investors are usually under no illusions that investing in cryptocurrencies will be a rollercoaster ride. The price can rise and fall at an incredible pace. However, what are the underlying reasons for this renowned volatility?
Let’s take a look at some of the fundamental reasons.
The first point to make is a general one about the relationship between volatility and financial markets.
Volatility, by nature, has a negative connotation in the mind of many investors. This is because it is a description that is normally used in conjunction with uncertainty. Often it reflects a degree of chaos in financial markets, and the potential for losing money.
All of these things can happen in a volatile market. But, this can actually be a healthy thing, to a certain extent. In fact, volatility often creates a chance for traders to profit when prices fluctuate.
If you want the ultimate example of financial market volatility you only have to look at how events unfolded in the global financial crisis back in 2008. The Dow Jones plummeted by almost 800 points in a single day. This was more than enough to spook anyone with cash invested.
These extreme events are rare in the main stock markets but it is fair to say that there is a greater level of unpredictability and price movement in crypto markets, but why is this?
A fundamental reason why crypto markets are invariably more volatile is that there is sensitivity to news events and investor concerns. Now, these events can also influence prices in more mainstream markets semi-regularly. However, the crypto markets are nowhere near as mature or populated by institutional investors.
Large trading firms and institutional investors are less swayed by events in established markets as price movements rarely move as violently as they did in 2008.
By comparison, crypto markets tend to be comprised of lots of individual investors. This can create a lack of liquidity as well as a greater level of sensitivity to individual news events.
Recent tweets by Elon Musk about his Bitcoin investments saw extreme price movements. This would not have been the same reaction if he was talking about a specific stock listed on the main markets.
A lack of liquidity, the fact that crypto markets are still in their infancy compared to established stock markets like the Dow Jones, and the investor profile of those playing the crypto markets, all contribute to the volatility.
It may well be the case that as crypto markets develop in maturity they align more with the characteristics and behavior of the main markets.
In the meantime, at least you have an idea of what to expect in terms of volatility when you decide to put some of your cash into crypto markets.