Curious Case of Crypto Market Fluctuation

Key Highlights

• The crypto market is witnessing an unending freefall, having lost over 2 trillion dollars in 6 months 
• The Global Crypto market cap has diminished by 67% and is now down to 950 billion dollars
• The largest cryptocurrency Bitcoin-has experienced a devaluation of 70% from its exceptional rise in November 

Cryptocurrency has been one of the most polarising subjects among investors. Predominantly, Millennials and Gen-Z have embraced it with open arms, whereas the old-school investors are still hesitant or outrightly critical of investing in the unregularised market. The jury is still out, with the complainant and defence making their case.

With such fluctuations in the market, booking profits amidst the persistent volatility seems an enticing investment option indeed. But first, one must be game to experience the chills of instability and the calm of investment. 

What’s Causing Such Volatility in the Crypto Market? 

The crypto market has experienced yet another roller coaster in six months, blindsiding investors and business pundits worldwide. The newsrooms that hailed the meteoric rise of the digital currency in November, when its global market cap reached a mammoth of 3 trillion dollars, are now reporting about its drastic fall. Several factors can be attributed to such volatility. The worldwide inflation and rising interest rates have impacted decentralised currencies like cryptos. Investors are looking for more safe and risk-free options to park their funds. The hostile geopolitical climate, rising fuel prices, and a looming pandemic have culminated and concocted an uncertain atmosphere for investing. 

Few other significant factors that have fueled this situation are:

• The critical stances that governments worldwide are taking against cryptocurrencies have also discouraged investors. 
• China banned all the private trading and mining facilities of cryptocurrency last year. 
• The news of the Indian government evaluating whether to prohibit private crypto trading is filling the papers. 
• The United States of America is considering implementing regulations to scrutinise illegal money transfers. 

The above instances have substantiated the possibility of the impending government intervention in the crypto markets.

Investors lack clarity regarding the rules or laws that might be imposed on the trading and taxes levied on these digital currencies’ profits. Such uncertainties have resulted in the decline of the prices of cryptocurrencies, accentuating their volatility. To completely understand the volatility of cryptocurrency, it is necessary to get the basics right. 

Cryptocurrency 101

A cryptocurrency is a digital currency constructed to function as a medium of exchange via computer networks using encryption algorithms. The encryption technologies ensure that it can be an alternative for currency and function as a virtual accounting system. And the accounts are maintained through cryptography instead of a centralised system. This decentralised system allows individuals to hold onto their wealth without bounds or seizures.

The individual must maintain a cryptocurrency wallet to use these digital assets. Such wallets can be stored on computers, laptops, mobile phones, and various cloud-based services. 

Cryptocurrencies prices are hard to gauge, unlike fiat currencies. It does not enjoy the backing of central states or some other medium of exchange that the government sanctions. This assurance from the states accentuates the faith and solidifies the value of fiat currency. 

The management of the supply of money and inflation is under the purview of central banks. Due to the absence of any regulatory body, the cryptocurrency is not insured and is prone to hacking on account of being a digital asset.

Its devaluation is not correlated with inflation like fiat currency due to its predetermined supply. 

Cryptocurrencies are still in their infancy stage, and visibly volatile, but several factors have been identified which determine the value of cryptocurrency.

Factors Determining the Value of Cryptocurrency

There are various factors from which cryptocurrencies derive their value. The most important being supply and demand. However, many external and internal factors directly or indirectly influence the fluctuation of these digital currencies. 

Supply and Demand

Cryptocurrencies are not immune to the principle of supply and demand. The supply aspect of the cryptocurrency is quite famous as the mechanism entails consistent publishing of token minting and burning plans. Cryptocurrencies such as Bitcoin have established a fixed maximum supply, meaning their quantity will never exceed 21 million. And there are other digital currencies, such as Ether, that have not capped their supply. Cryptocurrencies manage inflation by burning existing tokens to prevent the exponential supply, and this further entails transferring them to an unknown address in the blockchain. 

The monetary policy of each cryptocurrency varies. To manage the price, different cryptos employ different methods:

• Bitcoin increases its supply systematically when the new block is mined on the blockchain.
•  Ethereum provides a set reward per block mined. They also pay out for adding ‘uncle blocks’ to the existing block, which facilitates the efficiency of the blockchain. 
• Sometimes the money supply is managed exclusively by the team in charge of the Defi Project, who may decide to release or burn the tokens to command it. 

The utility and awareness of the project also impact the supply and demand of the cryptocurrency.

• When a cryptocurrency is identified as a new investment avenue amongst investors inevitably increases the demand for the cryptocurrency and ultimately limits its circulation.
• The demand for cryptocurrency increases when it enjoys widespread utility.

• Ethereum blockchain launched many Defi projects and became necessary to perform transactions as many projects were hosted on the blockchain.

• Such unparalleled utility resulted in an exponential demand for Ether. Making it one of the most sought-after cryptocurrencies other than  Bitcoin. 

• The announcement from Elon Musk bestowing Dogecoin as an alternate payment mode for their online merchandise store of Tesla prompted a worldwide intrigue and demand for the cryptocurrency.  

Mining 

The process of generating new tokens of cryptocurrencies and verifying transactions is called mining. Establishing and maintaining a state-of-the-art system with expensive equipment is necessary to mine cryptocurrency. The cost incurred in mining new tokens ultimately increases the value of these digital currencies. The cryptocurrency won’t be mined if the value does not offset the costs. The miners’ recompensation drives the inflow of new tokens into circulation. 

Any demand variation affects the supply, ultimately impacting the price. 

Cryptocurrency Exchanges

Listing tokens on various crypto exchanges also determines the value of the cryptocurrency. Popular tokens like Bitcoin and Ether are traded and listed across multiple exchanges. The investor does not have to bear additional costs, which they might if they transact with smaller cryptos listed only on a few exchanges. Therefore,  the investors prefer cryptos that are listed in more than one exchange. 

The more visible the token is on multiple exchanges, the higher would be the demand. 

Whales

Crypto whales are the community or single entities that hold massive bitcoin wallets valued at around 1 billion dollars. They manipulate the market by transacting their substantial holdings and profit from the volatility of the unregulated cryptocurrency market. They are infamous for using techniques to inflate and deflate the market value of the cryptocurrency with their massive purse. For example, cryptocurrency whales might strategically sell their large holdings, initiating a bearish trend among the investors.

After the prices hit rock bottom, they acquire a major chunk of cryptocurrencies to further increase their influence on the market.   

Regulations

As we mentioned above, the cryptocurrency market is still a newborn. Impending guidelines and regulations are yet to be set by the government. This uncertainty and insecurity seeps into the market and fluctuates cryptocurrency’s value. 

Many lawmakers globally have taken an antagonistic stance against the currency’s decentralised nature, impacting the overall market cap.

Why are Cryptocurrencies so Volatile? 

Most of us are now well-versed that the crypto market is highly volatile and full of uncertainty. This is due to a dearth of information and regulations on the crypto market. Hence, this attracts short-term investors and disinterests the institution.

Let’s take a deeper look to examine why cryptocurrencies are experiencing a daunting decrease in value.

Lack of Fundamental Information

Unlike the share market, the cryptocurrency listed in the exchange doesn’t add value or provide services to the outside world. There is a lack of information and an abundance of speculation. This makes the situation tough for the investors to determine the value of cryptocurrency. This perplexity of investors can be reflected in the volatility of the market.

Institutional Investors

Institutional investors are yet to partake in investing in cryptocurrency. Banks are reluctant to venture into an unregulated market. Institutional funding can potentially limit the volatility with their large trading desks. They can also establish mutual funds where they transact on behalf of the investors. 

Lack of Regulations 

Cryptocurrency employs a decentralised system because there is hardly any oversight from a regulatory body. This makes investors vulnerable to market manipulations. Which then, in turn, fluctuates the markets. This discourages institutional investors, too, as they wouldn’t want to invest in a market that is yet to regulate or protect their investors against market manipulation.

Investors 

The crypto market doesn’t attract long-term investors. And those who plan long-term prefer to go for more conservative options. In contrast, the cryptocurrency market attracts investors who quickly want to book profits, benefitting from its volatility. Such habits further accentuate the fluctuations in the market. 

Current Market Volatility of Cryptocurrency 

To gain better clarity on the current state of cryptocurrency,  let’s glance at the fluctuation the two major cryptocurrencies, Bitcoin and Ethereum, experienced in the last six months. 

The Volatility of Bitcoin in the Past Six Months

SOURCE: Coindesk 

• Values as on closing of the 1st day of the month 

The Volatility of Ethereum in the Past Six Months

SOURCE: Coin Desk

• Values as on closing of the 1st day of the month 

How can this Volatility Diminish?

Despite being highly volatile, these trending digital currencies still hold the attention of investors worldwide. Steps are to be implemented to correct the high volatility of this digital currency.

• Clarity on rules and regulations regarding the crypto market transaction from the government.
• Cryptocurrencies find widespread acceptance and utility among merchants.
• Transparency for the investors on Defi Projects they’ve invested.
•  Investment from the Institutional Investors.
• Participation of Long-term Investors.