Crypto Is Volatile — But Why?

Crypto volatility has been a major feature of the asset class that has made or ruined many investors over the years. This has left the curious wondering what typically affects volatility.

Cryptocurrencies are tradeable, meaning that they’re similar to stocks, commodities and securities. The price at which they trade depends on the demand and supply in the market, and the relationship between the two typically determines any change.

Consider financial markets. They are influenced by macro factors such as interest rates, inflation, and other monetary policies. Additionally, industry-related developments and national or global events also have an impact. The same principle applies to crypto. 

According to Jacob Sansbury, CEO at trading platform Pluto, markets can expect to see rather pronounced volatility in digital asset markets for some time. 

Consider the stock prices of the big Web2 giants, including Amazon. They experienced  pronounced price surges and drawdowns in their early years. Multiple times over the last couple of decades, they ran up in price and then crashed as much as 90%.

That can be ascribed to the fact that any novel technology is likely to experience exponential rates of adoption. The same can be about Bitcoin, Ethereum, Solana and a number of other blockchain networks.

“A difference with digital assets, though, is that their rate of adoption is even higher than that of most traditional technology companies,” Sansbury told Blockworks. “According to some estimates, the rate at which digital assets are growing has been double that of the internet itself.”

“This accelerated user growth feeds into the boom-bust cycles, and so too does that fact that digital assets have very much been driven by retail users from around the world.”

Long term, he expects this volatility to become less pronounced, especially when it comes to the big networks such as Bitcoin and Ethereum. Eventually, the rate of adoption is likely to slow as more people get exposure to these networks and, in turn, get more comfortable using them. 

“This will take years to play out. And until then, we should expect surprising swings in both directions,” Sansbury said.

When discussing volatility, consider various asset classes in terms of their respective risk and exposure to external factors. In ranking assets in the investing world from “most risky” to “least risky,” we would typically sort them as: 1. crypto 2. private equity 3. public equity 4. bond markets.

Central bank action is a major influence affecting overall liquidity across all these markets, according to Simon Schaber, Spool DAO’s chief business development officer.

“If liquidity is rising, as we saw under heavy quantitative easing in the recent past, then it lifts asset classes up like the incoming tide lifts a ship in a harbor. The most exposed asset classes get lifted the highest and the fastest,” he told Blockworks.

That’s why investors saw a massive rally in crypto, venture capital and meme stocks while more conservative assets rose only slowly and real bond yields even turned negative, he explained.

“If we consider this high level of correlation to the global liquidity situation in combination with the large influence that [venture capital] firms like a16z, Sequoia, Alameda, Jump, etc. have over crypto markets, then it is easy to understand that high volatility commonly happens in times of rapid and seismic macroeconomic shifts,” Schaber added.

But as this market matures — bringing with it less uncertainty — we should start seeing less volatility.

Varun Kumar, CEO at DeFi trading platform Hashflow, shared when he expects crypto to see lower volatility.

“When it is clear how exactly crypto can be integrated into the current financial system and traditional financial institutions are ready to implement it, we will see widespread adoption, giving digital assets more trust and, thus, stability,” he told Blockworks.

For cryptocurrencies to overcome volatility, he believes institutions need to find a solution for integration, regulators need to recognize their role and the general public must see crypto as more than a trading opportunity. 

Crypto prices have also fallen after negative regulatory or geopolitical developments, such as China intensifying its crackdown on the asset class and Russia’s invasion of Ukraine. They’ve also tended to mirror the fluctuations in the stock market, highlighting a link between crypto and more traditional assets.

Aside from these factors, prices of new digital assets with a relatively small market cap can also be easily tilted with a significant amount of cash, Chris Esparza, CEO and founder of Vault Finance, told Blockworks.

“With many traders poised to profit from these price swings, many compensate by injecting cash. However, as market capitalization rises, volatility tends to decrease,” he said.

He used bitcoin as an example, pointing out that it is generally less volatile than ether and the price offset is nearly impossible due to the larger market cap. 

“With more funds flowing into the crypto ecosystem from retail and institutional investors, there will be more balance and less volatility over time,” he said, adding that although the time frame is difficult to predict, we can expect a less volatile crypto ecosystem in about five years.

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