$20 000. The price of Bitcoin in USD about 7 months ago. $8 000. The price of Bitcoin now.
Now that’s some serious volatility. Other cryptocurrencies were not immune to these crazy price swings. Altcoins across the board experienced some big ups and downs over the same time span, which rose to a record-high valuation of $800 billion before plummeting below $300 billion just weeks later.
Why is this market so volatile?
The key reason for these dramatic price swings is one of liquidity. Take a simple example. Say you have a house for sale in your neighbourhood in a small town. It’s the only one for sale. So, you figure your house is worth $300 000. If someone really wants to live in your neighbourhood in that particular town, they will likely have to pay close to your asking price, or even out-bid a competing buyer. That’s low liquidity.
A house down the street from you, similar in size and features, is added to the market. They’re asking $275 000. Uh-oh. You are going to have to compete with your neighbour now. You might just have to lower your price in order to get that sale. There still isn’t much liquidity, so you have to drop your price pretty dramatically to compete with your neighbour.
A few more houses go up for sale nearby. Eventually, there are many more to choose from. Some are higher-priced and some are lower priced. As more and more houses are added to the market, some at higher prices and some lower, the price you’re asking becomes more stable due to the liquidity of the market. Now there are houses for $275 000, $285 000, $300 000, $320 000, and so forth. Your price doesn’t have to vary as much to be in the median range of all of these choices.
Now, of course, there could be some bad news in your town that causes the whole market to shift down. Maybe a nearby factory lays off hundreds of employees. Prices in the whole neighbourhood will suffer. Or conversely, a company announces it is expanding into your town. Great! Lots more jobs are available and your neighbourhood’s prices climb.
The cryptocurrency market is a lot like a small housing market in a small town without a whole lot of liquidity. Compared to the gargantuan big city nearby known as the stock market, there just isn’t a whole lot of liquidity. This is a market whose entire capitalization is less than a single corporation, such as Apple, which stands today at more than a 900 billion dollar market cap. The whole cryptocurrency market, as of now, hovers around 300 billion dollars. It’s tiny.
To give a little more perspective on just how tiny the cryptocurrency market is, the entire global stock market has been hovering around a value nearing $70 trillion (with a “T”). This offers a whole lot more liquidity than cryptocurrency does.
When good or bad news hits the world of the stock markets, stocks can move up or down in price significantly, but due to the much greater liquidity, there will always be more buyers and sellers to perform the supply and demand tug-of-war that maintains a certain degree of equilibrium in the market. A ten percent drop, for example, in the stock market, is considered a devastating crash. A given cryptocurrency can vary in market cap by ten percent within a few hours on an average day because it has much, much lower liquidity. A bit of good or bad news can cause a dramatic jump or drop in this much smaller market.
The average altcoin market cap is miniscule when compared to the stock market. This means a trader can see massive gains in a fairly short time since it really doesn’t take a great amount of buying activity to bolster the price, or selling activity to cause a drop. This is part of what makes investing in smaller market cap currencies so exciting.
Over time, as the cryptocurrency market grows, liquidity will increase and volatility should subside. This is still a long ways off, especially when you compare this market to the big numbers in traditional markets. For now, it’s important to have the right mentality when investing in cryptocurrency. It’s tempting to think of it as a get-rich-quick scheme – and it’s pretty hard to resist looking at it this way when half the comments on any given forum regarding cryptocurrency refer to “lambos” and exclaim, “To the moon!”
What this is really about, is a change in the way money, and our financial system in general, functions; moving from the current centralised paradigm toward a decentralised system whereby money is not controlled by a few manipulative agents. This is a process that will not happen over-night. It will take patience, perseverance, and a ton of work by a bunch of dedicated people, to get there.
So what’s the best strategy for investing in cryptocurrencies right now, but also for the long term?
Firstly, you should never invest more than you can afford to lose, and you should never incur debt in order to buy cryptocurrencies. Since this is such a volatile market, if you get caught in a situation where you need your investment money, and things go sour, you could be in financial trouble. Start small and do your own research into cryptocurrencies. Look for currencies that have active development teams (you can check their GitHub updates), strong potential solutions to problems, and good fundamentals (check out the people behind the technology).
Secondly, avoid getting caught up in FOMO (fear of missing out) or FUD (fear, uncertainty, and doubt). It is tempting to jump on a rocketing price in the hopes of getting rich quick, but it’s wiser to invest small amounts you can put aside on a regular basis, regardless of current market conditions. Of course, that isn’t to say you can’t take advantage of subdued markets during a bear trend, but don’t get too caught up in trying to time your buys. More often than not, you will gradually lose value if you try to follow this movement, unless you’re really lucky.
Finally, be willing to hold your investment for a long period of time. Traders in the stock market measure their growth by the year. In cryptocurrency, it’s tempting to measure it by the day or even by the hour. Sit back, and let your money work for you. Try to exercise that patience muscle and hold for long-term potential.
If you really can’t resist the temptation to do some day-trading, set aside a small amount, say 10%, to try out some day-trading. This can “scratch that itch” you may feel you need to satisfy, without risking too much of your investment. Keep the rest of your funds safely tucked away on a hardware wallet, such as a Ledger Nano S or a Trezor. Keeping your funds off exchanges is not only safer, it will also reduce the likeliness of you impulsively jumping on a FOMO train and losing long-term gains.
Tolerating volatility requires perspective; looking at things with a long-term vision. Zoom out on that market graph and you will see that, in the long term, despite the dips and bumps, this market is heading up.
*It should be noted that this is absolutely not professional financial advice. Do your own research, and do not risk more than you can afford to lose. Cryptocurrency is highly volatile and risky. Learn about it and then explore investment when, and only when you are ready to give it a shot.