Why are Bitcoin, other cryptos so volatile?

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While cryptocurrencies are catching the fancy of investors, their volatility is keeping many away.

This special explainer on digital assets takes a closer look at the volatile nature of cryptocurrencies.

Why is the crypto market so volatile? Is it safe to buy cryptocurrencies during the “dip?

And why are economists and business leaders, including Warren Buffet and Paul Krugman, calling crypto a “mirage” and predicting its demise, even as many ancillary technologies keep popping up around it?

Experts give their take on why cryptos are jumpy in nature and why the nature of the market is so volatile.

The cryptocrash of 2022

A fortnight ago, Bitcoin took a brutal tumble, dipping (briefly) below $30,000 (Dh110,193) for the first time since July 2021. Currencies such as Ether and BNB have also seen similar falls, leading to many experts talking of a “crypto winter”.

The fall of the Terra stablecoin made the overall crypto market unstable, wiping out more than $200 billion in the cryptoverse. Stablecoins are cryptocurrencies whose value is pegged or tied to that of another currency, commodity or financial instrument. The value of Luna Terra plunged by about 80 per cent, making the coins almost worthless.

Satoshi Nakamoto, the anonymous inventor of Bitcoin, designed the currency to circumvent traditional banking infrastructure after the 2008 economic crisis. When introduced in 2009, Bitcoin had a price of zero, and in July 2010, it was $0.09. Since then, Bitcoin’s price has zoomed to the thousands and has also fallen sharply during its short history.

From just around $2 in 2011 to $6,900 in 2020, to almost $70,000 in 2021, before tumbling down below the $30K mark, the digi currency has been doing a volatile dance for the ages. (See graphic).

On May 11, Bitcoin closed at $28,305, the first time it slipped below $30,000 since July 2021.

Why is the cryptocurrency market so volatile?

Dr Pedro Sigaud Sellos, associate dean of the Mohammed bin Rashid School of Communication, programme director and assistant professor of communication and information studies, American Unversity in Dubai, explained: “It all boils down to the logic of markets that follow the principles of supply and demand. The tricky aspect of cryptocurrency is that it is still hard to specify the actual value they bring to their holders.”

How is this currency market similar to the stock market?

The main difference between cryptocurrencies and company stocks, for example, is that the stock exchange trades stocks or shares of a specific company. In contrast, cryptocurrency exchanges trade in digital currencies.

“The company stocks represent a part of the actual company, representing ownership, even if it is a tiny part. There are ways to evaluate the company’s actual value, such as the cash flow statement and the income statement. With cryptocurrencies, their value is subjective, and it is difficult to identify their sources of value,” Dr Sellos explained.

“Finally, the capital volume invested in the stock market is much higher than cryptocurrencies. If you look at the New York Stock Exchange, the largest stock exchange in the world, they have a market capitalisation of over $27.2 trillion as of 2022. The global cryptocurrency market cap is currently less than two trillion USD,” he said.

Is Bitcoin too volatile to be a currency?

Volatility is a red flag when it comes to adopting the existing cryptocurrencies, said Dr Sellos. “Low volatility means that markets are stable and offer reliable opportunities for investors, with high chances that those markets will offer similar rewards in future. It also means a longer wait for financial compensation,” he said.

However, greater volatility means the financial reward can be higher, but uncertain. The crypto market is still relatively new, so volatility is expected and vulnerable to “big fish” or “whale” traders, the owners of large amounts of crypto. “Since large volumes of crypto are owned by few large investors, their trade decisions can make the crypto market more vulnerable,” he added.

Is it a good idea to buy cryptocurrencies when the prices are low?

The general rule of investment is to “buy the dip”, which can also apply to crypto. “However, I would advise small investors and even large ones to commit only a tiny part to crypto investments, given its volatility,” said Dr Sellos.

“Financial savings for one’s children’s education, for example, shouldn’t be put into crypto. It is advisable that volatile assets represent a small percentage of one’s investment portfolio,” he advised.

Why are economists and business leaders saying crypto will ultimately meet its demise?

Many economists and investors see cryptocurrencies as risky investments, even scams.

Warren Buffet is famous for investing in companies that generate value for shareholders and society, so it is a deal-breaker to invest in something that doesn’t provide any real value.

It is hard to find the actual value generated from crypto, and that’s where the main problem lies with cryptocurrencies in general.

“The fact that they rely on blockchain technology is something that the financial sector and governments will probably learn over time, since blockchain provides many benefits such as security, decentralisation, reduced costs and speed,” explained Dr Sellos.

Will markets stabilise in future and can cryptos be traded like regular currency?

“Only time will tell, but as I mentioned previously, the volume of capital invested in crypto would have to be much higher to see less volatility. It is still hard to tell,” he said.