The wide fluctuations in crypto market prices are often identified as one of the key barriers to the asset class’s mass global adoption. The volatility that underscores digital assets market prices – in many ways, misunderstood – could hold opportunity for digital asset traders. A shift in how one views volatility may be in order, though.
Volatility and risk tend to be white and rice in the minds of traders across markets. This psychological paring of the two, mutually exclusive, concepts plays into why the bulk of institutional capital remains on the sidelines, regarding cryptocurrencies being an asset class they would dip their toes into. A study by Fidelity Digital Assets – performed early in 2020 – came to findings of similar effect. Which offers an idea of the influence the phenomenon has on trader behaviour.
What Is Volatility?
Institutional traders – who are usually handling a ton of other people’s money, and have set targets that allow for minimal risk taking – tend to equate volatility with risk. So much so that the CBOE Volatility Index, which gives a reading of the S&P 500’s implied volatility (more on that in just a bit) is nicknamed the Fear Index. The term, volatility, is nothing to be feared though. Now that we’re certain of what it is not, let us now turn our attention to what it is.
Volatility, by virtue of its psychological relationship with risk, usually implies loss of funds, to the typical trader. However, risk and volatility are in fact, quite separate from one another. The key separating factor between the two concepts is that volatility is measurable, while risk – on the other hand – is the result of innumerable variables. A thing of chance. Therefore, immeasurable.
Volatility – in purely formal terms – denotes just the degree of movement in an asset’s price, in any direction. When besuited market whizzes speak of volatility, they are generally referring to Realized Volatility. Market Volatility’s second head, Implied Volatility – on the other hand – gives a measurement of what the market expects future volatility to look like. This particular sentiment is expressed in Options prices.
The two heads of the beast known as Volatility interplayed, usually offer reliable insight into impending market moves. When Implied Volatility is at a higher level than Realized Volatility, that usually denotes an increase in volatility. Digital Asset market volatility dynamics are, interestingly, different to what is typical of classic markets.
In the incumbent market system, volatility tends to move inversely to price, with the VIX typically going in the opposite direction of S&P 500 price trends. Whereas with Bitcoin, volatility tends to trend in unison with price moves.
Order In The Chaos?
While many traders fear volatility, an increasing number of institutional traders have begun to dip their toes into the crypto pond. Thy brings increased liquidity, which narrows spreads, and matures the space.
While stablecoins have done a great deal to offset the trepidation of many traders – causing an increase in crypto in trading volumes since inception in 2018 – there is still room for growth. Major companies seem to be stepping up to offer digital asset-related services, under regulation, to more users.
Crypto volatility, however, could be something traders will simply have to become accustomed to, as most markets allow for a stabilization period, by operating within certain hours. Crypto – on the other hand – trades 24 hours a day, 7 days a week. Volatility could simply be endemic to crypto markets.