Investing in the world of crypto can be exciting, and it can create new opportunities and ways to earn interest on your investments. At the same time, as with most investments that are potentially high reward, it’s also high-risk.
Anytime you’re investing, you must understand the fundamentals that drive its value in one direction or another. With that needs to come an understanding of the true risk of whatever you’re thinking about investing in.
In other words, while investing in the crypto market offers higher than average portfolio returns, it’s essential for crypto newbies to start by allocating a small amount at first. Investing what you can afford to lose as a new investor as well as researching how to invest in cryptocurrency is a must. Educate yourself about the potential upside and downside of the digital currency you are planning to invest and learn the investment case in each trend.
The term volatility refers to a measure of how much the price of an asset goes up or down over time. The more volatile something is, the riskier it is, generally. At the same time, there’s more potential you’re going to see higher returns or, on the other side of things, higher losses. These fluctuations occur in short periods of time.
Crypto, which is a new asset class comparatively speaking, is volatile, with a lot of potential for upward and downward movement.
Typically, when you hear someone talking about measuring volatility, what they’re referencing is historical volatility. This number comes from looking at prices over a set time period, which is usually either 30 days or a year.
The prediction of movements in the future is implied volatility.
A method known as beta can be used, which shows the volatility of one stock relative to the market. You can also look at the standard deviation of an asset, which measures how widely the price diverges from averages historically.
Investors look at volatility as a factor when deciding the risk of an investment. When you invest in something that’s volatile, you believe that it has a potential reward greater than the loss of your investment.
You can diversify your investments within an asset class with something like an index fund when you’re a typical retail investor. You can also invest in different asset classes. For example, your portfolio might have a combination of volatile stocks and less volatile bonds.
Then, there’s crypto, which as an asset class is only just over ten years old. During its short lifetime, crypto has seen major rises and falls, and as a result, it’s considered to be more volatile than stocks.
We tend to associate market volatility with being inherently bad, but that’s not necessarily the case.
While there are periods of major volatility that can be bad, like what happened in 2008 during the Financial Crisis, extreme price volatility isn’t all that common. From day-to-day, it’s usually considered normal, healthy volatility.
There are a lot of different cryptocurrencies, but the most well-known and followed is bitcoin. Bitcoin’s price fluctuates for many different reasons, which increasingly look to be tied to some of the things that affect volatility in the stock market.
For example, the price can fluctuate because of changes in supply and demand, user and investor sentiment, regulations from the government, and the news cycle.
While you can’t measure the volatility of crypto in the same ways as the stock market, all you need to do is look at the price charts. You can see massive peaks and valleys along the way, which tend to happen faster and in a more extreme sense compared to mainstream assets.
Many of the reasons for mainstream volatility are similar in cryptocurrency markets. For example, the media and speculation power these swings.
Some feel like the effects is amplified in crypto markets because there is less liquidity than there is in conventional financial markets.
Right now, the crypto markets don’t have a large system of institutional investors, and they aren’t backed by major trading firms.
A lack of liquidity paired with volatility can be a self-perpetuating cycle in crypto.
Unlike asset classes with a controlling agency or government backing them, crypto isn’t controlled by any central agency. There’s no regulatory framework guiding them as it stands right now, although that could change.
This lack of a centralized authority and anonymity both compel crypto investors and make them nervous or skeptical.
There’s also a tendency, especially among young investors, to want to turn a profit quickly when they invest in crypto. Then, they might quit crypto altogether when they lose money, which leads to volatility.
The laws of supply and demand are pertinent here too.
Cryptocurrency is a digital asset, so the price is completely determined by supply and demand. There is a limited supply, so an individual or entity with big holdings can influence the markets much more significantly than they might elsewhere.
As a new asset, bitcoin is still in the phase of price discovery. For any asset and not just crypto, this is its most volatile period.
Bitcoin has taken hold and shown it has a form of new value, but there’s a gap in understanding about what that long-term value could look like.
Bitcoin and cryptocurrencies are like any other investment at their core—people buy them with an understanding of the risk, hoping that it becomes worth it.
All investments carry risks, but if you look over the past decade, Bitcoin is one of the best performing asset classes, despite its young age.
You should think about how to be a longer-term crypto investor if it’s something you’re interested in.
Giving yourself a longer timeline and a fully diversified portfolio are going to likely give you more consistency.
It’s an interesting time to trade crypto, and especially bitcoin. Retail buyers are slowly moving away from being the dominant force. Instead, corporate America and money managers are starting to flood into the crypto marketplace, and it’s only just the beginning.
There could be a growing sense of legitimacy in the coming years, which will create more stability.
If we look at historic patterns across other asset classes, the more adoption and acceptance there is in an investment product, the less volatility there’s likely to be. Also, the higher Bitcoin and other cryptocurrencies go, perhaps the less risky they become.
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