Reasons for The Cryptocurrency’s Volatility
One of the major differences between the stock market and the cryptocurrency market is the high volatility of the latter. For instance, the volatility of cryptos in a period of one month is equivalent to the volatility of stocks experienced in four years! Why is this the case? Several reasons have been advanced to explain this phenomenon and they range from herd mentality to thin order books.
The fact that virtual currencies lack intrinsic value has also been put forward as contributing to the high volatility of this segment. Unlike corporations who are either selling services or products and in the process generating profits or losses, with virtual currencies that is not the case. Cryptos don’t return dividends obviously and only a small amount of the value of a particular digital coin goes into its evolution and this makes valuing it hard. It is thus near-impossible to determine when it has been oversold or overbought or when it is overpriced or underpriced. Thus instead of relying on fundamentals, market sentiment is relied upon in the crypto currency sector.
The absence of regulatory oversight has also been blamed for the volatility in the virtual currency market. While some governments have indicated that they will regulate the sector and with some already clamping down hard, regulatory oversight in this segment is still in its infancy. This limited regulation leads to market manipulation and this introduces volatility. In turn institutional investors are discouraged from venturing into it. Consequently, without institutional investors who have the capacity to introduce efficiency as well as soften market volatility, the result is even more volatility.
Thin order books are another reason that has been blamed for the high volatility in the virtual currency market. Due to fear of hacking and crypto assets getting stolen, investors in the space have been taught to avoid keeping their digital currencies on an exchange. This results in most of the supply that can be traded being in an off-exchange wallet and not on the order book of an exchange.
In the stock market the opposite is the case – the transactions of a public firm’s tradable stock are all conduced on one exchange. This makes it highly likely that a big market order will cause slippage in either direction. Large traders are also in a position to manipulate the market to move in a particular direction resulting in increased volatility.
A significant portion of virtual currency investors are in it for the short term. Unlike in stocks where some investors expect to hold their stake maybe even into their retirement a significant number of crypto investors are looking for quick gains. This raises volatility levels.
As a result, this major issue in the crypto market, decentralized payment firm Havven has disclosed that it has obtained funds totaling $25 million which will be used to fight volatility in the virtual currency market. Havven intends to achieve stability in prices by applying a two-token model.
“Havven, as a decentralized payment network, will allow people to transact in a cryptocurrency that maintains a stable purchasing power. This will unlock numerous decentralized solutions, like insurance contracts, prediction markets, and decentralized asset trading platforms,” the founder of Havven, Kain Warwick, told Venturebeat.