Does cryptocurrency volatility mean cryptocurrencies are going to crash to zero and fade away? While some believe that is the case, their conclusion is simply incorrect.
Cryptocurrencies run on a technology called the blockchain. Think of it as a bank ledger that can't be modified. The blockchain has in recent years produced a wide range of uses that aren't tied to cryptocurrencies. These additional use cases provide validity to the blockchain in the wider economy and build a case that the blockchain is here to stay.
Additionally, new use cases for cryptocurrencies are coming to fruition all the time. From use within closed environments where a company might sell merchandise or services using its own cryptocurrency, to a facilitator for more efficient international financial transactions.
Bitcoin and Ethereum have both spread deep into the economy. They both get a lot of press and which one will eventually have the most use if often debated.
Mike Cagney, CEO and co-founder of SoFi, said the following at Fortune's Brainstorm Tech conference, "has some purpose but its application for commercial transaction is limited right now," Cagney said. "The blockchain and Ethereum, on the other hand, have absolutely fascinating infrastructure applications," he continued, mentioning the possibility to overhaul title insurance, which involves policies related to real estate, as one example.
I believe that bitcoin bears the potential to become the primary, or potentially the only non-government currency out there. Put differently; if Bitcoin or Ethereum are successful in proving that they are a good store of value, their price could easily go up by a factor of 500, making them currencies that could fuel entire markets.
Despite which cryptocurrency might find the most use in the economy, it's clear both are here to stay. In this article, you'll learn why price fluctuations can actually be a good thing, what causes prices to swing and factors that will lead to the eventual stability of prices.
Buying The Dip
With all the hype around cryptocurrencies, it can be difficult to sit on the sidelines thinking you are missing out on a once-in-a-lifetime investment. But then there's that volatility. Do you really want to get in one day only to see the cryptocurrency drop by $1000 the next day?
There's an easier way to go about it. Rather than dumping in all the money allocated to a specific cryptocurrency in one transaction, spread it out over time. Then, buy more only on dips. This is similar to dollar cost averaging. The technique will keep you out of huge spikes, which often fall back down, as evidenced by the recent $15,000 high that corrected around the same time the U.S. Stock market corrected. This technique doesn't guarantee you'll buy every dip, but at least you won't be buying peaks. Your average cost will be lower than most peaks.
Many people have used the above technique and have seen appreciation over time with it. When the price drops, consider the cryptocurrency on sale. It's a better value than it was the day before at a higher price. Consider that this is much different from what a day trader might do, which is extremely difficult to get right on such a short-term basis.
Being in a cryptocurrency for the long-term and buying dips will smooth out some of your investment's volatility.
As an aside, in cryptocurrency investing terminology, HODL is the term used for long-term holding, especially holding through volatility. The origin of the oddly named term is actually an accidental misspelling by an individual who meant to refer to the word HOLD. However, HODL caught on.
What Causes Prices To Fluctuate So Much?
What exactly causes cryptocurrencies prices to swing so much? Especially for bitcoin (BTC), which is most commonly used as a cryptocurrency? Because its main use is that of a currency, it is highly traded for speculation. This leads to lots of volatility in its price.
Cryptocurrency prices also fluctuate like the stock market. If there is a big sell-off in the stock market, it tends to be broad. Cryptocurrencies are not exempt from these large sell-offs. News about a cryptocurrency exchange hack can send cryptocurrencies down as well. Mentions of regulators looking to clamp down on cryptocurrencies and exchanges will also impact prices.
On the positive side, prices can rise when there is a big announcement of a well-known company using a certain cryptocurrency. Or even when a large investor steps in and buys millions of dollars of a cryptocurrency.
What Will Cause Prices To Finally Settle Down?
Regulators are starting to look more closely at cryptocurrencies. Especially with the volatility in prices and recent exchange hacks, regulators feel it is more important than ever to bring some stability to the market and protect investors.
Yves Mersch, a member of the executive board at the European Central Bank, mentioned to the Financial Times, "Even if virtual currencies are not money, central banks should still be aware of the potential risks they pose for price stability and financial stability,"
Besides regulators, large businesses and institutions that allow cryptocurrencies to become part of the business model will also help to bring stability to the currency. Currently, smaller investors who are mainly emotionally driven, are causing much of the volatility with their trading. As large institutions hold bigger percentages of cryptocurrencies, smaller investors will have less impact, reducing volatility.
Additionally, alternative investments such as ETFs and futures contracts allow people to invest in cryptocurrencies indirectly. Specifically for futures, many larger investors (called whales) often take big positions in futures. These large positions tend to stabilize futures prices, which could roll over into BTC prices.
For Long-Term Investors, Fear Not Fluctuation
The take away for long-term cryptocurrency investors is that short-term price swings shouldn't impact their long-term strategy.
For newbies looking to invest in cryptocurrencies, volatility will simply be a part of the game for a while. That means if you decide to walk the path of investing in crypto, learn everything you can and do your due diligence. Volatility doesn't mean cryptocurrencies are going to dissolve and go away. It's still very early days for cryptocurrencies. While there are more and more valid use cases for utilizing cryptocurrencies and the blockchain every month, there are many use cases that haven't even been thought of yet. It's all the more reason why cryptocurrencies and the blockchain are here to stay.
Marco Streng is CEO & Co-Founder of Genesis Mining.