While many markets have seen dramatic swings in valuation from time to time (think stock market, real estate, commodities, precious metals), there’s just nothing that quite compares to the spectacular rises and steep plunges in the price of cryptocurrencies.
2017’s Track Record of Volatility
Over the last year, we’ve seen a perfect display of this kind of volatility. For example, at one point, bitcoin’s value surged more than 1,900% to the delight of some crypto speculators and investors. Yet in June and July, it’s value plunged 36%, providing a reality check to many. Then in December, bitcoin’s price more than doubled to reach an ultimate valuation of nearly $20,000, then it plunged again briefly by 45%, while finally rebounding a little to end the year with about a 1,400% gain. If these kinds of wild swings scare you, then be afraid. They aren’t likely to end any time soon, and they have greatly influenced the general perception of the entire cryptocurrency market.
Lack of Regulation
Why is the cryptocurrency market so volatile? One important reason is that it is almost completely unregulated. The U.S. stock market is regulated primarily by the Securities and Exchange Commission (SEC). Its goal is to minimize the kind of chaos that an unregulated market would likely experience due to market manipulation, collusion, fraud, deception, insider trading, etc. In addition, the Financial Industry Regulatory Authority (FINRA) oversees stock brokers and investment firms, regulating trading by managing licensure and compliance with its rules and policies. Lastly, congress passes federal legislation, such as the Dodd-Frank act, which required transparency and accountability within the financial industry. There is currently nothing at all like any of these institutions overseeing cryptocurrency. Though some countries have begun to either encourage or crack down on the cryptocurrency market, these efforts are both piecemeal and in their infancy. It may be some years, if ever, before we will see any complete and coherent cryptocurrency regulations in place.
The Millennial Herd Mentality
A lack of regulation is not the only dynamic behind cryptocurrency price swings. Keep in mind that this is a relatively new market, with very few antecedents. Most people, including the heads of many of the largest financial investment firms, are sitting on the sidelines scratching their heads, trying to figure out exactly what cryptocurrency is and what to do with it. In general, volatility drives savvy investors away towards more stable investment opportunities.
Millennials, however, have jumped in as early adopters and brought their own brand of chaos to the market. With generally little experience as investors, especially as long-term investors, and hoping to make a quick buck, members of this age group are often willing to take investment risks that their more mature generational counterparts would eschew. In addition, they often have less disposable income to invest, causing many to make their bets on the cryptocurrency market with money that they cannot afford to lose, or may not even have. In addition, because they are relatively new to the investment game, they may not have the experience and savvy necessary to make good decisions for the long run. While investors with more long-term experience might use Hodl or dollar-cost-averaging strategies with a view to the future, millennials are more likely to engage in reactionary behaviors such as selling in a panic at the wrong time, buying impulsively at the wrong time, or doubling down with even more money that they don’t have.
The market size of cryptocurrencies is much smaller than with other forms of currency (e.g. USD, EU, CNY, etc.) and because of this, even small-volume buys or sells can have a major impact on their value. This problem is compounded by the outsized effect “whales” have on volatility. Since the value of any commodity is largely determined by the dynamics of supply and demand, when a few people with huge stakes in the market buy or sell, the price can jump or drop astronomically.
How can bitcoin or other cryptocurrencies be accurately valuated? Unfortunately, the kind of hard data that drives the decision-making process of experienced investors simply doesn’t exist in this space. Consequently, beliefs about the value of a token are often based on hopes, fears, and loosely-founded expectations. Uncertainty leads to volatility in any market, but few more so than this one. This should change over time as a retrospective analysis and evaluation of the history of the blockchain and cryptocurrency lead to greater understanding and predictability of this market. At the same time, it’s important to recognize that even in long-established markets such as the US Stock Market, predictions based on decades of extensive hard data can still fail.
What the Future Has in Store
Regulation is coming, though how effective it will be remains a huge question. Given the distributed, borderless nature of this market, it is possible that it can only be regulated on a global scale, and the likelihood of this happening is remote. Individual countries may impose bans or introduce regulations, but how effective they can be is doubtful. After all, attempts to control the Internet on a nation-by-nation basis have largely failed.
However, as the reach of cryptocurrency increases its penetration into mainstream commerce, both locally and globally, and as the stability, effectiveness, speed, and scalability of the underlying technologies improves over time, it is most likely that dramatic volatility will decrease and the value of the tokens that survive will increase slowly and steadily over the long term.
In addition, the experience and wisdom of investors is bound to increase over time, and as the larger hedge funds and financial institutions become more active in this market that should also lead to an increase in stability, and thus a decrease in volatility.
While this market currently resembles the “wild west”, and may continue to do so for a while, many believe that things will calm down and that cryptocurrency will eventually become a main stream competitor to fiat currencies.