Sirwin
Sirwin

Why is cryptocurrency so volatile?

By Resh Community | reshcommunity | 23 Jul 2022


With the modern-day revolution of blockchain, cryptocurrencies still face large volatility. What makes the crypto markets so volatile? Today, we will explore what causes the large volatility in the crypto markets. We will begin the journey by understanding how crypto assets pricing is set.

How are crypto assets priced?

The pricing of crypto assets are determined by supply and demand. The method of defining a price is by order book model. This essentially means that everyone who wants to sell or buy, can select a price and quantity of crypto to trade. The market price of the crypto asset is determined by the last executed trade. 

What does this have to do with volatility? We believe that centralized exchanges often have an incentive to move the price of crypto assets in a certain direction. The fact that all trades are handled on their servers means that they also have the capacity to do so (for tiny periods of time). This can be done to liquidate leveraged positions or for other reasons. Thus, we are convinced that centralized exchanges have a role to play in increasing the market's volatility.

What changed on Nov 2, 2018?

On November 2nd 2018, a new decentralized trading principle came out. This was Uniswap's DEX protocol for decentralizing Liquidity Pools and allowing people to trade between crypto assets. Shortly after, companies began tokenizing crypto-currencies (pegging them and creating a token) and copying the protocol on to numerous blockchains. 

This opened a whole new system in crypto that enabled people to trade their crypto assets without requiring permissions from a centralized party. This also meant that many cryptocurrency prices would start following each other's price. It also made it harder to manipulate the price of cryptocurrencies as it no longer relied on centralized exchanges, instead on decentralized transparent technologies.

What does the Liquidity Pool principle have to do with volatility? Well, in our opinion, Liquidity Pools help to ease volatility in the markets. This is because Liquidity Providers act as a middle party offering their funds up for trade. And the decentralized model of it allows everyone to create a liquidity pool. This ensures lots of money behind the pricing of crypto and requires a lot more money to move the price.

Globally Traded Market

Crypto-currency is a largely un-regulated, globally traded market. This means that even when you sleep someone is trading. Therefore, the cycles and price of cryptocurrency markets largely depend on market psychology. The market can be traded at all times, without restrictions, unlike in stocks where they are traded during certain times of the day, and with restrictions imposed. This largely means, that anyone can sell or buy any amount of cryptocurrency at a time. Like in the case of Luna, this means that large amounts can be sold on the market impacting the price heavily as other traders begin following. Typically this would cause FOMO to either buy or sell the asset aggravating the volatility even further.

In conclusion, the combination of market psychology, unrestricted trading, transparency and 24/7 global trading causes volatility in the cryptocurrencies markets. Is volatility bad? Most retail investors, institutional investors do not view volatility in a positive light. The same cannot be said for cryptocurrency investors who often bank on the volatility. Many new technologies have developed in the industry, forming entire new fields to study in crypto such as DeFi, NFTs, etc. 

Will crypto markets always be volatile?

Typically, the more money that flows into an asset, the less volatile it becomes, that is why alt-coins tend to be more volatile than larger crypto coins. As adoption and understanding of the technology grows, cryptocurrency assets volatility will largely diminish. Furthermore, as technologies and protocols develop, volatility tends to diminish.

 

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Resh Community
Resh Community

Resh is a community that focuses at bringing news & information to crypto pioneers. We love to inspire newcomers in the space and are keen on developing based on the "community first" motto.


reshcommunity
reshcommunity

Resh is a community of crypto enthusiasts. It's primary focus is to deliver knowledge to all those who seek it. Resh strongly believes that knowledge is power in crypto. As such we inspire our community to take better, more educated decisions. The community obviously has a bias in favor of cryptocurrency (as it's a community of crypto enthusiasts) but will also mention skeptical news. Link: https://blog.resh.community

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