Don’t panic: Understanding the cryptocurrency market’s ups and downs

Industry

After watching values slide by high double digits over the course of 2018, would-be cryptocurrency investors might be understandably leery about where the market goes from here. Do cryptocurrencies stabilise and then begin rising again? Will they keep falling? Or will 2019 see another roller-coaster year of wild highs and lows?

Blockchain believers insist that digital currencies are here to stay. But market swings will continue to be likely for a number of reasons. It helps if investors understand all the various factors that can drive cryptocurrency values up and down.

Reason No. 1: Usage

Bitcoin and other cryptocurrencies have been touted as a better alternative to government-backed fiat currencies controlled by central banks, as well as an easier way to conduct commerce internationally without having to exchange from one currency to another. But, especially since the spectacular run-up in prices in late 2017 – followed by a dramatic crash – cryptocurrencies have become largely speculative investments rather than currencies.

“The value of bitcoins handled by major payment processors shrivelled nearly 80 per cent in the year to September,” Reuters reported in late November, citing data from blockchain research firm Chainalysis. “That suggests the cryptocurrency is struggling to mature from speculative asset to a serious alternative to state-issued money.”

Some of the obstacles to cryptocurrencies’ usability – user difficulties and slow transaction speeds – might eventually be resolved through improved technologies. For now, however, such issues will likely continue to make adoption slow… and markets volatile.

Reason No. 2: Value

Like commodities such as gold, cryptocurrencies have value because of what people believe they’re worth. But Bitcoin, however, doesn’t behave like gold.

The two assets “could barely be more different”, write European researchers Tony Kleina, Hien Pham Thuc and Thomas Walther in a recent study. “Gold plays an important role in financial markets with flight-to-quality in times of market distress. Our results show that Bitcoin behaves as the exact opposite and it positively correlates with downward markets.”

Cryptocurrencies also don’t behave like other commodities we value, writes attorney Jay Adkisson in Forbes.

“A commodity is usually something that is consumed, leading to demand for more,” he writes. “Oil and wheat are examples; once a stock of those is consumed, another must be supplied. Cryptocurrency is not a commodity. There is no demand for cryptocurrency in the consumption sense, and an individual unit of cryptocurrency is not destroyed by a transaction but can be reused over and over such that most demand can be met by existing stocks.”

Reason No. 3: Regulation

Part of the appeal of Bitcoin and other cryptocurrencies is that they are free from control and potential manipulation by governments and central banks. However, that kind of oversight does help to provide stability by reassuring consumers and investors that their money is safe when they use fiat currencies. Without that, cryptocurrencies remain a greater risk than traditional currencies and securities.

“[B]ecause there is currently little or no regulation around coins, they are not comparable to listed equities in which there are both stringent disclosure requirements and listing requirements,” University of Michigan researchers Albert S Hu, Christine A Parlour and Uday Rajan write in a May 2018 study. “Indeed, the listing requirements for all exchanges mean that the analogy between ICOs and IPOs is literally semantic.”

The lack of regulation around cryptocurrencies also makes them vulnerable to manipulation, as a recent investigation launched by the US Justice Department underscores.

All of the preceding factors can add up to a lot of volatility in the cryptocurrency market, which can discourage wider adoption. However, changes in technology and regulation could help bring more stability and greater usage. The Lightning Network, for example – which aims to speed up Bitcoin and blockchain transactions – is “growing in use and capacity”, Reuters reports.  And lightly regulated markets such as Switzerland are paving the way for easier crypto trading.

If investors can weather the short-term ups and down, it’s possible that such developments could help stabilise the cryptocurrency market in the years ahead.

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