Putting Crypto Volatility in Context: What We Can Learn From the History of Bitcoin Crashes

12 Apr Putting Crypto Volatility in Context: What We Can Learn From the History of Bitcoin Crashes

Just as when the internet was a revolutionary back in the 1990s and Internet-related companies were generating significant rates of returns, the cryptocurrency market is currently in a similar cycle. New technologies take time to be perfected and adopted by the general masses, and there is a high risk of failure since there are many things that can go wrong. The topic of volatility may seem unsettling, however, there are indicators that cryptocurrency volatility is easing. Financial institutions, countries, and institutional investors are becoming increasingly confident in the asset. It’s uncertain when the volatility levels of cryptocurrencies will reach those of conventional assets, however, it will undoubtedly hit its full development at some point in the future. The value impacts investment decisions by depicting whether an asset is dangerous or not, and how its price may change on a daily basis.

The research on the volatility of crypto-assets is dominated by questions on portfolio risk, such as the assessment of this new asset class’s potential for portfolio diversification or hedging. This positive view is challenged, at least in part, by Klein et al. (2018) who claim that Bitcoin is “no safe haven and offers no hedging capabilities for developed markets”. Similarly, Bouri et al. (2018) find spill-over effects between Bitcoin and other assets, “particularly commodities, and therefore, [that] the Bitcoin market is not isolated completely”.

• By mid-November 2020, 29% of S&P 500 companies had more volatility than bitcoin (BTC) so far this year, according to VanEck.
• Market manipulation makes the general market unstable and highly volatile since the large orders created by these entities with the intent of manipulation would significantly cause sharp fluctuations in the market.
• While the path to stabilization remains unclear, these projects offer glimpses of optimism and a chance to earn profits during the bearish market.

Whales who hold their positions stagnant for a long time can make the market volatile since it reduces the asset’s liquidity. Meanwhile, whales who sell a bunch of their crypto at once can cause market value to shrink. When Beijing banned crypto outright https://www.xcritical.in/blog/crypto-volatility-important-points-you-should-know/ in September 2021, crypto prices fell hard and fast. The downside didn’t last, but international exchanges scrambled to drop Chinese users now that a legal gap had been patched. This is just one of the myriad reasons cryptocurrency experiences volatility.

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Knowing what causes crypto volatility is the first step in maneuvering the inevitable ups and downs. Despite the fact that a new country was making crypto mainstream, bitcoin values fell. Many investors worried that El Salvador’s troubled economy could burden the value of BTC.

Lesser volatility equates to lesser price movements and therefore, a lower probability of earning the desired returns. The ability to potentially make significant amounts of money is perhaps the biggest draw for many investing in cryptocurrencies. The sheer volatility of the market allows for the potential of higher returns, presenting a great opportunity for traders and investors to exploit the volatility of the market to make money in any direction of the market. Lower price volatility around bitcoin, and cryptoassets more broadly, should be seem as both a cause and effect of the uptick in the interest and investment of TradFi into cryptoassets. Bear markets have historically flushed out malinvestment across asset classes. During the dot-com crash of the 2000s, many internet-based companies were forced into bankruptcy.

Crypto Volatility Index Streaming Chart

Let’s take a look at historical cycles and price movement in order to gain perspective and context and set proper expectations for future price movement. 8 show that—unsurprisingly—expected volatility is usually higher for cryptocurrencies than traditional assets. The two exceptions are volatility of volatility (VVIX) and crude oil volatility (OVX, not-shown). The latter recently saw its highest levels since inception in 2008, which was primarily driven by the 2020 oil price war between Russia and Saudia Arabia and is therefore of no further interest to this study.

Is Volatility Good?

Since they’re so unpredictable, volatility is crucial to keep in mind when deciding whether or not and when to invest in a cryptocurrency. A very volatile cryptocurrency would be one that is highly unpredictable, with frequent and drastic price changes. A non-volatile cryptocurrency, however, is less risky because the price is more secure and predictable.

In the stock market, we have the CBOE Volatility Index (VIX) to measure the market’s projected volatility. According to the CBOE website, the benchmark index is a “30-day expected volatility of the U.S. stock market,” derived from real-time, mid-quote prices of S&P 500 call and put options. With prices for put P(.) and call C(.) options, strike K, current forward price of the underlying F, and risk-free interest rate r for maturity \(\tau\).

(Details on these factors come later in this article.) But broadly speaking, volatility is related to demand and supply. Something worth repeating is that the cryptoasset sector is much larger than just bitcoin. Although its continues to dominate business headlines and policy conversations, it is just one cryptoasset in a rapidly expanding ecosystem https://www.xcritical.in/ for tokenized asset products and services. For example, the vast majority of Layer 2 and more advanced tokenization projects do not run on the bitcoin blockchain. Rather the bulk of these innovative use cases are built on the Ethereum
ETH
blockchain, rekindling discussions of when torch of leadership might passed from BTC to ETH.

As more institutional investors and corporations invest in the crypto market, the effects of macroeconomic forces become more prominent. These players constantly rejig their portfolios to be optimized for global economic conditions. Macroeconomic factors like interest rates, inflation, and unemployment rates are becoming important crypto market drivers.

This has predominantly practical reasons as Bitcoin dominates in liquidity, especially for derivative markets. Our view is backed by the literature that finds strong interdependence within the cryptocurrency market (Ciaian et al., 2018; Corbet et al., 2019). Overall, the literature agrees that, as of now, cryptocurrencies show strong interdependence among each other, however, remain somewhat isolated from the dynamics of traditional markets. A recent study by Giudici and Polinesi (2019) extends this view by stating that “Bitcoin exchange prices are not affected by classic asset prices, but their volatilities are, with a negative and lagged effect”.

It discusses the factors behind price fluctuations, including market sentiment, supply and demand, liquidity, regulatory uncertainty, tokenomics, hype, whales, and macroeconomics. The article also provides risk management strategies such as diversification, stop-loss orders, dollar-cost averaging, derivatives, and volatility index usage to navigate the volatile market. Brokerage services for alternative assets available on Public are offered by Dalmore Group, LLC (“Dalmore”), member of FINRA & SIPC. “Alternative assets,” as the term is used at Public, are equity securities that have been issued pursuant to Regulation A of the Securities Act of 1933 (as amended) (“Regulation A”). These investments are speculative, involve substantial risks (including illiquidity and loss of principal), and are not FDIC or SIPC insured.

The two resulting volatility indices are cointegrated and the corresponding error correction model can be utilized as a metric for market implied tail-risk. Most observers of cryptocurrency markets will agree that crypto volatility is in a different league altogether. In 2016, the price of bitcoin rose by 125% and in 2017 the price rose again, this time by more than 2,000%. Following the 2017 peak that saw it hit new all-time highs, bitcoin’s price receded once more.