Volatility: The Necessary Evil Of Cryptocurrency And How To Handle It
Part of what has cemented cryptocurrencies on the map since they exploded into the mainstream investor market has been their volatility. Investors flooded to the likes of Bitcoin when, through November and December 2018, the value of the cryptocurrency increased in value exponentially.
However, such volatility is a two-edged sword, and the cryptocurrency market has shown that in 2018 with Bitcoin’s price shedding more than 50 percent at times from its year end price of $13,000.
The cryptocurrency market has also felt the ill effects of Bitcoin’s volatility because as a result of the price drops, Bitcoin’s trading volume, and even interest in the digital currency realm also decreases. The danger is that volatility can cause a large exodus of investors to occur which severely dents the hopes of other cryptocurrencies gaining mass adoption status.
Volatility should be at the center of attention if there is to be a future in which crypto is used widely in day-to-day instances.
However, it requires a lot of bravery, and some tactical know-how, to successfully navigate the lows, in order to keep oneself safe, and sane, as well as contribute positively to a burgeoning crypto economy.
Why volatility is important, but deadly
There is a lot to be said for the role that volatility played in helping cryptocurrencies reach the mainstream market.
Cryptocurrencies, and Bitcoin in particular, only made it into the mainstream media stream as a tool of the dark web when the infamous Silk Road was shut down. Back then, it was far from being considered a good investment for Wall Street types, but they soon joined the party.
Suddenly, banks, the thought leaders of banking and financial institutions all had an opinion on Bitcoin - many of them thought it was a fad, or even rat poison and far too volatile to take seriously, but conversations about Bitcoin were starting to be held in investment circles.
The Chicago Board Options Exchange (CBOE), and the Chicago Mercantile Exchange (CME) introduced Bitcoin futures trading on the 18th and 10th of December 2018 respectively. Goldman Sachs and Barclays are rumoured to be looking into crypto trading desks, and people could not get enough of this crazy asset that could double in price in a matter of weeks.
Stories of Bitcoin billionaires and overnight millionaires cropped up, and the individual investors flooded to be a part of the massive wave of Bitcoin mania.
This is why volatility was so important in establishing cryptocurrencies as a potential asset that could also be adopted as a currency in mainstream society. However, this same volatility is also what could kill that goal.
Itai Cohen, CEO of Homelend, a mortgage crowdfunding platform has noted to Cointelegraph that within their scope of property and mortgaging, they see volatility as something that drives investors away from the cryptocurrency market and into more stable investments such as the housing market. Their aim is to try and transcend the cautious housing investors while catering to a new, bolder investor who embraces this volatility.
“The high volatility of crypto-assets is the result of investors’ reliance on the so called ‘adoption syndrome’ - where the perception of an asset’s value is mostly based on expectations about its adoption by the community.”
“I believe that this is a key factor, more so because perceptions are much more volatile for a digital asset than for ‘real-world’ assets like gold, real estate, corporate profits or government backed currencies. In other words, there is a big gap between the physical world and the digital one.
“The mortgage industry is a perfect example of an industry that seems to be helping bridge the gaps, same as the real estate industry or any other industry that has a foothold in the ‘real’ world.”
The problem is, if people enter crypto when the market is at its most Bullish, profiting off the upward volatility, they need to be strong enough to stomach it at its most Bearish, and the volatility takes a big down swing.
How to handle volatility
Handling volatility is nothing new for institutionalized investors. Assets, stocks, bonds, and even forex is prone to swings, but the problem is that cryptocurrency volatility is off the charts.
Additionally, investors in cryptocurrency are often new to the game and have not experienced the range of swings before - watching their money both grow, and shrink substantially by the hour.
As the stock market having been around far longer than the cryptocurrency one, it is a good place to begin. Their tips in handling these sickening lows, and highs, are relevant and can be carried across to crypto trading.
Just like in the cryptocurrency space, there are long term investments and short term investments in the stock market. Roger Ma, founder at Lifelaidout, a certified financial planning company in New York, explained how, in stocks, it is important to not forget about your time horizon:
"Investing in stocks rewards you in the long term. These day-to-day changes in the market shouldn't affect you."
This reflects very much in the same vein as the so-called ‘Hodl’ strategy for cryptocurrencies. Essentially, the strategy says that there is no need to let ‘day-to-day changes affect you’ rather just hold onto your cryptocurrency to avoid the volatility altogether.
Ma also mentions another strategy which shares similarities with cryptocurrency - dollar cost averaging. Under this strategy, you buy an investment on a fixed schedule. This investment strategy essentially stops you from making rash moves into, and out of, the marketplace.
“As long as you have a good plan in place and have thought about the time horizons where you need the money, then the slightly small moves in the market shouldn't matter to you.”
The Dow Jones has been known for its big drops, even over the course of just one day. Scott Hanson, founder and senior partner at Hanson McClain Advisors, made an important note on these kinds of drops.
“A 250-point drop for the Dow today is only about a one percent decline. But that same drop when the Dow was at 10,000 would have been a 2.5 percent fall.”
This basically speaks out about the bigger picture, and how important it is to zoom out of the charts. For Bitcoin, just six months ago, in October 2017, people were celebrating wildly that Bitcoin had broken the $6,000 mark. However, a few times already this year, people were panicking that Bitcoin would hit $6,000.
Safe havens
There are times however, when even seasoned investors in crypto feel the pinch and want to either take profit, or a high, and escape the market. But, escaping the market for an investor is difficult if that money is designated for assets.
Many have seen value in diversifying their portfolios, not only across cryptocurrencies, but also hedging their bets with some more stable assets, primarily gold.
Gold
Gold is an asset that is almost synonymous with stability, and, it has a long running history with cryptocurrency as its antithesis. There have been times where it is apparent that gold and cryptocurrencies have inverse relationships with the precious metal speaking in times of crypto lows.
Daniel Marburger, director of Europe-based online gold dealer Coin Invest said that gold coin sales increased fivefold on Jan.16, the same time cryptocurrencies were crashing.
“[Tuesday] was a hell of a crazy day,” Marburger said, adding that “emails and phones did not stand still with customers asking how they could turn their crypto into gold.”
Even before cryptocurrencies, gold was known to spike in times of stock market volatility as its value tends not to move in line with other assets such as equities or property.
Cash
Cash is another safehaven that crypto investors easily flock to when the cryptocurrency market takes a dive, as it is as simple as selling the digital currency for something that is at least usable in day-to-day life.
The issue with turning digital currency to cash is that the value of cash is constantly shifting but slowly, losing value, and as an investable asset, it really is not a good bet.
Similarly, as a safe haven for cryptocurrency the problem is that a dreaded cycle of selling low and buying high can develop as investors sell their assets in times of lows, and buy them back when the market is booming again, and probably, over valued.
Image source: U.S Bureau of Labour Statistics
Bonds
Bonds issued by governments are generally perceived as safe haven investments because the general view is that countries are often more financially secure than companies, and more stable than cryptocurrency. However, if the bond issuer can’t meet interest payments or repay the capital when it’s due, you could lose your whole investment, and it has happened before, even in economies as big as China’s.
All of these safe havens primarily have ways in which a crypto investor can escape the volatility of the market and protect their assets from falling to far. However, the primary issue is that they are taking their investment totally out of the crypto economy, and with the volatility, it is often hard to get back in, and profit, when the markets are green.
Guy Melamed, CEO of Zeex, a company that tries to mitigate crypto volatility by turning them into things such as gift cards, reiterates the point that by leaving the cryptomarket totally in search of a safe haven means that there is a gamble about getting back in when the time is right.
"Even though top cryptocurrencies such as Bitcoin and Ethereum have made tremendous progress within the last few years, the latest dips in the market have had many investors understandably looking for safe havens where they can park their wealth without dropping out of the crypto market.”
“Many will turn to conventional safe havens like gold, stable-coins and exchange-traded funds. But it’s hard to buy low when the whole herd is stampeding in the same direction. What we've found in our work, is that inflation tracking crypto gift cards can be stable because they are linked to inflation and not speculation.”
A duty to weather the storm
There is evidence to suggest the volatility of Bitcoin is lessening, that the wild swings are not as wild, and that they are in fact getting more manageable over time. This has a lot to do with the rise in adoption and the distribution of Bitcoin across a vast and varied market.
On the other side of things, volatility is also sometimes prized. Arthur Hayes, the CEO of BitMEX, a Bitcoin mercantile exchange, trades in volatility and sees it as important to the space.
“I am a volatility trader at the end of the day,” Hayes said. “We make our money if it is volatile. If it goes up or it goes down, if you have Bill Gates calling it a fraud, then short it - I don’t care. Or, if you think it is going to be one mln dollars in a few months, great! Buy it, still don’t care, we just match trades.”
But, according to Daniele Bernardi, advisor at volatility fund Volactive and CEO of PHI Token, volatility is lessening, and it is because not everyone is after that ‘three-digit return’. Bernardi told Cointelegraph:
“The extreme volatility that characterizes the cryptoworld today is clearly linked to the very high yields they have generated in recent years. If we want the crypto to continue to offer triple-digit returns as an asset class, it is inevitable that volatility must remain high. Even if the same is also linked to liquidity, for which the crypto community will inevitably grow the more we will mitigate the returns to the volatility.”
“This is already happening, because the volatility of Bitcoin in the first years of life was more than 300 percent per year, while now it varies between 50 and 100 percent per year. Currently there are no asset classes that have similar volatility except for the volatility of the VIX index which is a volatility indicator in turn.”
It requires those who are invested in Bitcoin, and other cryptocurrencies, to stick with it and work through the volatility in order for the digital currencies to survive, and thrive.
Mainstream adoption has kicked off in earnest, but it requires a lot of hard work from those who are in the market now, to stay in it, and to ride out this storm. Once the volatility is under control, a new wave of adoption can surely kick off.