Almost every time the topic on the viability of cryptocurrencies as mediums of exchange, store of value, and units of account comes up, critics point out that they are too volatile for these functions.
While these might be true, there is a good side to their high price volatility. It provides opportunities to investors, in particular, day traders, to grow their worth. The obvious way to exploit crypto volatility is to buy when the price is low and sell when it is high.
That is not the only way, though. You can also do what is known as shorting. This is leveraging the price falls in the bearish market to make profits. We won’t go into detail about here but you can read more about shorting crypto in this article, now onto volatility.
But what exactly is price volatility?
In a nutshell, the volatility of an asset is the rate at which its price swings up and down. Changes in market supply and demand cause this movement. When the demand for a cryptocurrency like Bitcoin exceeds the supply, the price tends to go up. On the other hand, when its supply exceeds demand, the price goes down.
In this case, the supply is what is being offered for sale by holders (HODLers) primarily, and not so much what comes from emission (mining reward).
It is important to point out that volatility is more than just up and down price movement. With all the other factors kept constant, an asset whose price moves up and down twice a day is less volatile than one whose price moves a few times more.
However, there are other factors to consider. One of those is the size of the swings. A change in the price of about 0.5% in a day is way less volatile than one that is about 30%.
Last but not least, is how fast the swings happen. For example, one asset might take about two days to complete a cycle while another takes hours.
Cryptocurrencies tend to have more, larger, and fast swings in a day when compared to traditional assets like gold and even stocks.
What is terrible about cryptos having high volatility?
While the price volatility offers traders opportunities to grow their worth, its negative sides cannot be ignored.
One of those is that it keeps crypto away from being adopted for real world use cases. Because of high price volatility, for instance, cryptos struggle to perform the functions of a currency. If you are a business and you decide to price your products in terms of Bitcoin, you can either make huge profits or significant losses in a matter of minutes. After you’ve sold an item, the value of the currency can shift upwards or downwards significantly.
This is not entirely a problem of cryptos, though. It is partly an issue because often you have to settle your bills using fiat. That means after making sales, you have to convert the cryptos you earn into sterling pounds to pay suppliers, employees, and settle other costs. However, if you found yourself in a system where your clients pay in crypto and your suppliers and creditors accept crypto, volatility wouldn’t be a huge problem.
Another negative impact of volatility is that long-term investors or those who intend to hold crypto as a store of value, high volatility can find it hard to ascertain its future performance.
What causes cryptos to have high volatility
It is a collection of factors that make cryptocurrencies to be very volatile. One of those is that cryptos is a relatively new asset class, and most of them are still discovering their actual value. Today we don’t know Bitcoin’s right value, and it might take a long time before that question is settled.
This makes sense, even more, when you consider that cryptos are not backed by any other assets except for stablecoins. The prices of stablecoins do not move wildly because these assets are pegged to other assets such as the US dollar.
Another thing that makes the prices of cryptocurrencies volatile is that there is no central authority that controls the emission and, in particular, the number of units in circulation.
With fiat currency, for example, the issuing authority (the Bank of England in the UK) might decide to increase supply to bring down the price or mop up excess cash from the circulation. This has the effect of increasing the currency’s value. No one has the power to do that with cryptos.
It is also important to point out that because cryptocurrencies are digital assets and transactions happen online, the transactions are completed within minutes and even seconds, which makes the price movement happen faster.
Recent reports indicate that the volatility of cryptos, particularly that of Bitcoin, is slowing down. We might be looking at a future in which cryptos’ price movement will be at the same level as traditional assets. Of course, that will take away some opportunities from day traders.