Volatility and Its Impact on Cryptocurrencies
Sudden price fluctuations are no surprise to investors in the world of crypto. It’s general knowledge that the crypto market strongly correlates with the movements of bitcoin itself. Usually, if the price of bitcoin goes up, the market sentiment is also positive, affecting the growth of other cryptocurrencies and the market capitalisation as a whole.
However, the same goes for when bitcoin is down. Often enough, especially during rapid price shifts (either up or down), we hear the magic world ‘Volatility’. So what is this volatility?
Volatility is generally characterised as the degree of variation of an asset’s value over time. That means volatility is the measure of how much the price of any particular asset went up or down over time. Generally, the more volatile the asset, the higher the risk. Simultaneously, this offers investors the potential to achieve higher earnings or greater losses in a relatively shorter time than more stable and less volatile assets.
In practice, volatility is usually measured in two ways:
- Via beta coefficient, which measures the volatility of an asset in comparison to the broader market – market portfolio, usually represented by stock index (a typical benchmark is the S&P 500)
- Through standard deviation of an asset, which represents the level of risk and measures the degree of price deviation from its historical average.
Short-term crypto market volatility is practically impossible to predict. For example, in May 2021, bitcoin lost over 37% of its value in 11 days. The primary cause is bitcoin’s relatively low market capitalisation compared to other assets, such as gold, stocks, or real estate.
Short-term fluctuations are mostly caused by various macroeconomic novelties and opinions of influential subjects in the market. Therefore, short-term value predictions are pretty risky. They are just informative predictions based on on-chain data and technical analysis.
Volatility at the Crypto Market
Volatility is one of the primary factors used in the evaluation of any investment. Investors are usually willing to risk more if they believe that the potential payoff is worth the possibility of losing the majority of the investment. The same goes for crypto investments.
However, there are several ways to reduce the potential risk of your crypto investment portfolio.
- Buy & Hodl: Due to the short-term unpredictability of bitcoin value, many investors ‘ignore’ volatility by buying and holding the assets for the long term. In the world of crypto, this strategy is called ‘buy and hodl’. These investors believe that the bitcoin value will grow over the years because of its characteristics such as transparency, decentralisation and finite amount. Historically, nobody that bought bitcoin and held on for at least four years has lost the investment.
- Diversification – For retail investors especially, it’s recommended to diversify the investment into several cryptocurrencies to eliminate the risks. The majority of specific (nonmarket) risks in the portfolio will be eliminated by allocating resources into 20 to 30 assets. One popular strategy is investing in the ‘basket’ of cryptocurrencies. One such is our popular Fumbi Index Portfolio, which presently consists of the top 26 cryptocurrencies on the market. Minimising the risks is also possible by a suitable combination of assets (ideally by combining the asset with a negative covariance).
- Cost averaging – One of the investment techniques for eliminating the negative impact of volatility. It’s a long-term strategy where the investor buys smaller amounts of assets over a certain period regardless of price – for example, investing monthly €100 in bitcoin for two years rather than investing €2,400 at once. Investors’ cost averaging plans often differ based on their investment goals.
- Combination of volatile and less volatile assets – If you are of the investors with risk aversion, you should combine the risky assets with less risky ones from more traditional investment options. The ideal solution could be our Fumbi Bitcoin & Gold index, which consists of a unique combination of the fast-growing potential of bitcoin and the stability of the real gold. Fumbi Bitcoin & Gold is a unique product in its field which came to existence thanks to the portfolio’s modern theory. This index aims to create diversification that can lower the volatility of cryptocurrencies while still achieving a high return on investment.
Four Important Tips to Help You Manage Your Investments
- Avoid the FOMO effect – the FOMO effect is the fear of missing out on something others enjoy (at least temporarily). Investing under the FOMO effect can make you buy a cryptocurrency you would otherwise never consider. The same goes for the rapid growth of cryptocurrencies, where the fear of missing out causes you to buy the cryptocurrency at its peak. Avoid the FOMO effect; invest regularly and over long periods.
- Set your investment goal – Remember, investing in cryptocurrencies is not a tool for immediate fortune. That’s why it’s essential to define your investment goals. When investing in crypto, it’s good to plan your entry (purchase) point and exit point (when you’ll sell) and stick to it. Investing with a set goal can help you better cope with any price shocks.
- Don’t let your emotions control your investments – The lack of knowledge and investment experience often results in an emotion-driven panic. As a result, they sell their investment portfolios even though their investment is down. Don’t let your emotions influence your investment decisions. To be a successful investor doesn’t mean becoming rich overnight but building a fortune through rational and systematic investing.
- Long-term investing is the way – Investors shouldn’t enter the market just for a quick profit. It’s important to see investing in crypto as a long-distance run based on patience and endurance. Constantly evolving cryptocurrency technology is still at its developmental stage. It will take some time before the technology, and various innovations will be ready for everyday use within the cryptocurrency ecosystem.
“I’m convinced that about half of what separates the successful entrepreneurs from the non-successful ones is pure perseverance.”
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