In December 2020, Bitcoin was trading around $20,000 (roughly Rs. 14.85 lakh). In January this year, it crossed $40,000 (roughly Rs. 29.70 lakh). Continuing its bull run, it reached an all-time high of $65,000 (roughly Rs. 48.27 lakh) by April. Then in May, it crashed and throughout June it remained below $30,000 (roughly Rs. 22.28 lakh). The coin began rallying again around July 20 and surpassed $45,000 (roughly Rs. 33.42 lakh) last week for the first time in almost three months. Similarly, most other popular cryptocurrency coins have behaved over the past few months. While this has resulted in a windfall for some, some others may have also lost a part of their investments due to the high volatility in the cryptocurrency market.
The one question most troubling to a majority of investors is: Why is cryptocurrency so volatile? The cryptocurrency market has been volatile from the beginning but the last few months have been particularly a wild ride. There are a few factors that determine the trajectory of this market.
Cryptocurrency is still an emerging market, gaining rapid popularity as well fuelling quick disenchantment among investors. Despite all the media attention, this market is still minuscule when compared to traditional currencies, or even gold. This means even smaller forces – a group of people holding large amounts of crypto coins – can influence the trade. Even if they sell only Bitcoins, it would be enough to crash the whole market.
The cryptocurrency market thrives on speculation. Investors bet that the prices would go up or go down to make profits. These speculative bets cause a sudden influx of money or a sudden outgo, leading to high volatility.
Purely Digital Asset
Most cryptocurrencies, including Bitcoin and Ether, are purely digital assets with no backing of any physical commodity or currency. Which means their price is determined entirely by the laws of supply and demand. In absence of any other stabilising factor, like government backing, any number of reasons may lead to a fluctuation in demand or supply.
The blockchain or other alternative technologies on which these coins function are still evolving. It has only been a decade since the Bitcoin idea was first proposed. There is the scalability problem, when a smart contract is not validated with the timeframe expected, creating sudden downward pressure.
Unlike real estate or the stock market, this market is not seen as needing expertise. So mostly part-timers are investing in it. They come with a hope of making quick gains but sometimes when that does not happen, they lose patience and withdraw from it. This frequent involvement and withdrawal also lead to volatility.