Volatility is a crucial aspect of investing in crypto because of its effects on risk and return, that's why we decided to have crypto volatility explained in our article. Cryptocurrencies are a novel technology and they tend to be more volatile compared to other assets like stocks or bonds. In this crypto volatility beginners’ guide, we are going to explain the implications of crypto’s volatility, its causes, and why it’s important to know about crypto volatility.
On 19th May 2021, the price of Bitcoin plunged over 30% within a few hours. Price movements of this size are not common in stocks or other assets. But, crypto is a different game altogether. It’s quite common to see Bitcoin’s price rising or falling by thousands of dollars within 24 hours.
In crypto, price changes as large as 10-30% in a day are a norm rather than an exception. And if we talk about crypto assets like memecoins, for example, Dogecoin (DOGE), prices can go up or down by even larger percentages! Because of these extreme price swings, investing in crypto can sometimes be like maneuvering an airplane amidst a cyclone.
- 1. What is Volatility?
- 2. What is Crypto Volatility?
- 3. Explaining Crypto's Volatility - What Makes the Crypto Currency Market Volatile?
- 4. How to Measure Cryptocurrency Volatility?
- 5. What is the Cryptocurrency Volatility Index?
- 6. Why is Volatility Important to Understand?
- 7. How to Take Advantage of Crypto Volatility?
- 8. Crypto Volatility FAQs
1. What is Volatility?
We call the weather volatile when there are sudden and unexpected changes in temperature or other factors like the speed of wind or rainfall. Similarly, in trading or investing, volatile simply means frequent and large price swings of an asset like crypto or a stock of a company. So, when the asset price is volatile, it can go up or down by a large amount, for say 5-10%, frequently and in a short time frame.
Since volatility means rapid price swings in any direction, it often leads to high risks. For instance, you may be expecting the price of a crypto to go up but it can suddenly change direction and take a dip dive because of high volatility. So, if you want to make regular profits from crypto, or any other asset, it’s absolutely necessary to understand crypto volatility and the ways to deal with it. Understanding the differences between the bull and the bear markets may also be a useful knowledge for crypto investors.
2. What is Crypto Volatility?
There is no other asset with which volatility is as much associated as it is with crypto. Many traders actually love crypto because of its volatile nature. It may sound counterintuitive, but it’s an interesting fact about crypto. As we have just mentioned, crypto looks inherently volatile as there are big and frequent price swings in the price of almost all cryptos like Bitcoin or Ethereum. So, what is cryptocurrency market volatility?
Crypto volatility means the tendency of any crypto’s price to change frequently and by a large percentage in a short period. The price of any asset fluctuates with every tick because of constant buying and selling. Therefore, the price in the market is never fixed. However, because of wide swings in crypto’s demand and supply, the price changes can be unpredictably high in cryptocurrencies. Crypto volatility increases even more when there are developments like a change in regulation, an innovation, or a new case of adoption. So, how does high volatility in crypto work? Let’s look for the answers. And in the meantime, we encourage you to take a look at our guide including crypto trading strategies for beginners which also takes into consideration the changing nature of cryptocurrencies.
3. Explaining Crypto's Volatility - What Makes the Crypto Currency Market Volatile?
Crypto investors often think why is crypto volatile or why is Bitcoin volatile. There are a number of reasons for crypto price volatility. These reasons explain why there is a higher volatility in crypto as compared to stocks or commodities (like gold or oil). Let’s explore these cryptocurrency volatility factors.
3.1 Cryptos Don't Have Any Fundamental Value
Stocks have fundamental values because they represent ownership in a company. When you own a stock of Apple Inc., you have an ownership stake, no matter how small, in the company. Similarly, a commodity like gold has an intrinsic value because it can be used to make jewelry or even key components of electronic devices. But till now there is hardly any solid real-life use case for most cryptos.
Even though there are merchants accepting cryptos as a mode of payment, their number is still pretty small. So, the only thing most people buy or hold crypto for is to sell it to others for a higher price. This means cryptocurrencies mostly have speculative demand or supply. This is a primary reason why the price of cryptos fluctuates so much in an unpredictable fashion. If, knowing that, you still want to invest in crypto, on our website, you can find tips how to buy Bitcoin.
3.2 Speculation, Speculation and Speculation
In the absence of any intrinsic value, speculation is a major driving force behind price changes in crypto. Investors often speculate about the value of crypto going up or down based on hype, discussions on social media, and statements of crypto influencers. For example, a single Tweet by some tech evangelist can lead to huge price fluctuations in cryptos like Dogecoin (DOGE), for example.
3.3 Low Liquidity
The trading volume of many cryptos, especially the smaller and newer ones, is often pretty low. When the trading volume is low, even a small change in demand or supply leads to a big price movement in a short period. So, low liquidity is one of the main reasons behind crypto volatility .
Crypto as a technology is still in its very nascent stage. So, crypto needs to overcome a number of concerns like regulatory uncertainties, security issues, and technological complexities. In 2021, China put a blanket ban on all sorts of crypto transactions. This led to uncertainties in the crypto market and higher volatility. Similarly, instances of fraud or failure of crypto platforms (like the implosion of crypto exchange FTX or stablecoins UST and LUNA in 2022) create uncertainties and crypto volatility. All these factors makes investing into cryptocurrencies tricky. Additionally, there is a number of options to choose from, that is why prior to making any decision, it is good to make a research and identify cryptos with the greatest potential.
3.5 Retail Traders & Investors
A large number of crypto investors are retail investors. Retail traders or investors tend to have a shorter investing horizon and a more speculative investing style compared to institutional investors. Higher retail activities contribute to more volatility in crypto.
4. How to Measure Cryptocurrency Volatility?
Since volatility is an integral part of how crypto works, we have to learn to live with it. The first step towards dealing with high crypto volatility is knowing how to measure crypto price volatility.
So, how is crypto volatility calculated? To answer this question, we have to look at the two types of crypto volatility:
- Historical volatility
- Implied volatility
Historical volatility indicates the frequency and extent of price changes in a crypto token in the past. We can calculate historical volatility with the help of standard deviation in the price of crypto over a given period in the past.
The calculation of implied vitality is a little complex. It generally involves looking at derivative data of an asset's price and putting the required value in a sophisticated mathematical formula called Black-Scholes option pricing model.
5. What is the Cryptocurrency Volatility Index?
From an investor's or trader’s point of view, the value of volatility or the changes in volatility are much more important compared to how volatility is calculated. A volatility index is basically an indicator showing the value of volatility and the change in volatility with time. Some leading volatility indexes in the crypto domain are Crypto Volatility Index (CVI) and the Bitcoin Volatility Index (BVIN).
The next important question is how to read a volatility index. If you look at a volatility index, you will know the value of volatility at a particular time or whether it’s going up or down over time. So, a crypto volatility index is like a barometer indicating the mood of the crypto market. When volatility is going up, you can expect bigger and more frequent price changes. On the other hand, when volatility falls, it shows that the market is going to be quieter and price changes would be relatively smaller. When trading at platforms such as Bubinga, it is worth to take a look at the current volatility index, before making any important investment decisions.
6. Why is Volatility Important to Understand?
After answering what is cryptocurrency market volatility, the next question that may arise is why is volatility important to understand. The primary importance of crypto volatility is its effects on the risk and return of your trades.
As we just discussed, when crypto volatility goes up, we are likely to see bigger and more frequent price movements. This means the mood of the market is now more erratic and you are likely to see unpredictable price swings in any direction. This inevitably raises your risks.
On the other hand, when volatility falls, market prices move in a smaller magnitude. So, there is a lower risk in the market. Knowing about market volatility helps you manage your risks and have better clarity about your expected returns when trading crypto at ByBit or any other crypto exchange. But is high volatility always bad or is low volatility always good? Let’s answer it.
7. How to Take Advantage of Crypto Volatility?
A basic principle in investing is that a higher return is associated with higher risks. So, when volatility is higher and there are chances of bigger price movement, this means you can make higher profits when your trades go right. So, higher volatility provides more profit opportunities for high-skilled traders. However, you need to remember that if the potential for upside movement is higher, the same for downside movement is higher too.
So, to earn higher profits during high volatility, you need to have adequate risk management to manage your downside risks. Following strict stop-losses can help you manage your downside risks. If you can control your downside risks through risk management, you can earn high profits even when the crypto market volatility is high.
8. Crypto Volatility FAQs
8.1 ❓ How is crypto volatility measured?
There are two common ways of measuring volatility. Firstly, we can look at past price changes of a crypto asset to calculate standard deviation and historical volatility. Secondly, we can use options price data to calculate implied volatility to forecast future volatility.
8.2 ❓ What causes high volatility in crypto?
High volatility is an important feature of cryptos because of their speculative nature, lack of intrinsic value, regulatory uncertainty, and technological complexities.
8.3 ❓ Is high volatility good for cryptocurrencies?
High volatility simply means there is a higher probability for bigger and more frequent price changes. So, higher volatility increases your risks. However, if you can manage downside risks, it’s absolutely possible to earn high returns amidst volatility, which should be clearer now, after we have crypto volatility explained above.