For crypto investors, any given day can feel like a roller coaster ride. The price of Bitcoin, for instance, regularly goes up or down by more than 5% in a day. In contrast, stock indices like the S&P 500 or Dow Jones Industrial Average rarely see swings that large.
During a bad turn for digital assets, it’s natural to wonder what caused the price drop — and what you can learn from it. Of course, each day on the market may bring a different answer for why crypto is down (or up), but understanding the basic mechanics behind crypto’s volatility can help you make better decisions.
Here are some of the many possible reasons behind big drops in prices:
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Low liquidity. If a cryptocurrency is trading at lower-than-usual volumes, weird things can happen, like a single large trade throwing off the market by swinging prices closer to the value of that transaction.
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Speculative trading dries up. High-risk trading with hopes of quick returns can end badly when momentum wanes.
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Loss of trust. Trust in a product is a price driver. If it evaporates, prices can, too. In addition, because crypto is a novel asset class based on relatively new technology, signs of trouble such as cyberattacks or product failures can adversely affect the overall market.
Whatever the reason behind the crypto price trends of a single day, it’s important to remember that volatility has been a defining part of crypto investing.
Even Bitcoin.org, the website started by Satoshi Nakamoto to help explain Bitcoin, doesn’t shy away from that fact when it states: “relatively small events, trades, or business activities can significantly affect the price.”
Making sense of the bigger picture
In addition to dropping a lot in one day, cryptocurrencies are vulnerable to macroeconomic factors that can push down values for weeks or months.
In November 2021, a price decline turned into a sustained nosedive that continued until midway through 2022, when prices stabilized far below their lofty former highs.
Crypto’s drop coincided with price declines in many asset classes, but the declines in crypto were far steeper. For example, the S&P 500 dropped around 25% but has clawed back about half of those losses. Meanwhile, Bitcoin is still worth less than half of what it was before Thanksgiving 2021.
When explaining crypto’s drop, sometimes called “crypto winter,” experts point to the same root cause: Investors were looking to offload risky assets of all types amid economic uncertainty.
Adam Grealish, director of investment solutions and GM of advisory at Altruist, a software platform for financial advisors, said the scale of these big declines in crypto prices undercuts “the story about it being digital gold and a place where folks are moving to protect wealth.”
“While there’s an interesting theoretical argument for it, empirically it trades much more like a risky, high-volatility asset,” Grealish said.
The macroeconomic environment in 2022 hasn’t been kind to risky assets.
Red-hot inflation has driven prices up. In response, the Federal Reserve raised rates, which lifted the interest charged for all types of loans. When money is more expensive, stocks and other assets can suffer. As a result, investors tend to flee riskier investments, including crypto.
While this is bad news for investors and customers alike, Greg King, founder and CEO of crypto investment firm Osprey Funds, says this is part of an evolutionary process that will improve the industry in the long run.
“Our view is that it’s a positive in cleaning out some of the dead wood there,” he says. “All of the companies that went under that were in the press were centralized operations with poor risk management.”
It’s impossible to know what course the crypto market could take from here.
If interest in cryptocurrency investing recovers to the levels seen in 2021, that could benefit people willing to weather the tough times. But don’t confuse a volatile asset for a basketball; only with the latter can you expect a bounce back because it fell. Volatility means that prices could still go in either direction.
