Irrespective of the amount of hype it has generated over the past few years, decentralized finance remains a murky topic, poorly understood by many.
On top of that, the cryptocurrency market is extremely volatile, making people skeptical about investing in crypto. Earlier in May 2021, the value of Bitcoin declined by 30%, while that of Ether dropped over 40% in less than 24 hours.
But by the end of the day, both currencies had regained substantial ground.
With such steep volatility, it’s understandable for one to assume if cryptocurrencies are a good investment. Should you take the plunge despite the volatility? Let’s explore in detail.
Why are cryptocurrencies so volatile?
Cryptocurrencies are generally volatile because of their low market capitalization and liquidity.
In addition to that, the cryptocurrency market is also influenced by speculations and rumors, which usually result in a massive fluctuation in prices. Volatility can be positive or negative for investors, depending on when they decide to invest.
Here are some reasons for crypto being so volatile:
- Decentralization: Since crypto falls under decentralized finance, the currencies are not regulated or ”printed” by a certain authority, unlike fiat currencies. Anyone can mine coins, which means there are always unknown sellers and buyers entering the market.
- No tether: Typically, traditional investments, like diversified funds and stocks, are tied to a value-based asset. If the company does well, the stock’s value rises. Poor company performance impacts the stocks negatively. But cryptocurrency is not backed by a commodity, such as gold. The value of cryptocurrencies is determined by the general sentiment in the crypto community. Thus, volatility is rampant since the sentiment changes often.
- Investor confidence: Investor confidence, or lack thereof, also plays a role in creating volatility in the crypto market. Often, investors are cynical about a currency in response to a change in community sentiment or another factor, bringing the price down.
- Speculation: The prices of cryptocurrencies are largely dependent on speculation. Speculators often buy currencies in the hope that their value will increase. This results in a massive influx of capital, which causes an upward spike in prices and volatility.
- Controversy: The crypto world is afflicted with controversy, considering coin mining uses a lot of energy. This is resulting in environmental concerns and increased costs. A big scandal can drive people away from cryptocurrencies, impacting prices.
Apart from these reasons, investors may also be concerned about the fact that they do not hold the real asset when they invest in cryptocurrency. Since cryptocurrencies are intangible, their investments only exist as digital assets on a blockchain. If this digital ledger is ever hacked or compromised, it will lose all value and become worthless overnight.
These risks combined with the lack of regulation contribute to volatility.
Is volatility always bad?
In another market or industry, volatility may have negative connotations attached to it. But many crypto investors see it as a means to make huge profits.
For example, by investing in Bitcoin early on, you could have made ten times the original sum if sold at its peak in Dec 2017. Similarly, earlier this year, when the crypto market faced a massive decline, many investors saw it as an opportunity to buy while prices were low.
They managed to make huge profits later when the prices went back to their previous positions.
If you are extremely confident about the future of cryptocurrencies and willing to take risks, then investing in this volatile market might prove beneficial for you.
However, there is no guarantee widespread adoption of cryptocurrency will become a reality, so it’s advisable to invest only what you are ready to lose completely.
Why is this good for an investor?
While volatility makes many wary of investing in crypto, some see it as an advantage. They can buy at lower prices before the bull run begins and sell just before the value drops.
The price movements of Bitcoin, Etherium, and other coins follow the same pattern action as traditional assets like stocks. Prices always move in cycles. This means that there is bound to be a bull run sooner or later once the prices drop after the market has cooled off for a bit.
Once this happens, there will be many who made money buying low and selling high. That’s why higher volatility also means greater potential profits.
Is cryptocurrency a good investment?
Considering the market volatility, investing in cryptocurrency is only a good option for people who are looking for short-term gains. Long-term investors may have to hold on to their coins for a while before their value appreciates.
In case you’ve missed an opportunity to buy cryptocurrencies at a low price, it may be wise for you to wait until the volatile times have passed.
But if you invested during these times, keep a close eye on your investments because there might be another sell-off sometime soon.
If you are willing to take risks and gamble your money, then investing in cryptocurrency may prove beneficial for you. Here are some tips to minimize your risk when investing in cryptocurrency:
- Diversify your portfolio. Instead of investing all your money in one coin, diversify your investments. Even if you lose money from one side, the other coin you’ve invested in may go up in price.
- Don’t fall prey to FOMO. The fear of missing out makes investors buy cryptocurrencies that are only popular at the time due to their hype and serve no value later on. A good example is Dogecoin.
- Keep up with market news. A single tweet from Elon Musk sent Bitcoin’s price up by 10%. But then another tweet from Musk brought it down by 4.3%. When you invest in cryptocurrencies, it’s important to keep up with the news and the moves made by renowned investors, as these factors impact the coins’ prices.
- Don’t chase the price rise. If something rises in value by 10%, you shouldn’t rush to buy it in the hope that it will rise further. Keep in mind that there is a high risk of it dropping, and once this happens, you might end up losing money on your purchase.
Conclusion
Having said that, investing in cryptocurrencies can be quite lucrative if you know what you are doing. You can protect yourself against risk by investing in different kinds of coins, keeping up with the market news, knowing the right time to sell, and diversifying your portfolio.
But if you’re not careful, you could end up losing money in the cryptocurrency market.