Bitcoin and cryptocurrency projects like Ethereum and Cardano were supposed to be stores of value and hedges against inflation. Instead, the cryptocurrency market, led by Bitcoin has moved in lock step with what’s happening on Wall Street.
How come? Why are cryptocurrencies now being treated like stocks?
Because cryptocurrency is so new, it is likely to move with the market as a proxy for investor confidence. The stock market is currently underperforming, and investor confidence is low while investor fears are high. And so too is the cryptocurrency market.
- Cryptocurrencies are likely to drift away from the market over time. Having said that, many businesses are adopting, investing in, and advocating for cryptocurrencies, making it difficult for cryptocurrency to move independently from the market.
- Cryptocurrencies are also depreciating at the same time that the market is correcting itself. This is due to a macroeconomic shift rather than a sole reliance on the stock market.
The stock market is a bellwether for investor confidence, and it is likely that the crypto market will follow suit. However, in the current market, investor confidence is being hammered. Investors are wary of the market, and the “fear and greed” index is near the “extreme fear” zone.
Increasing acceptance of digital currencies
Many consumers are beginning to see the benefits of digital currencies. From their safety and reliability to their ease of use, they’re starting to shift their attention away from traditional payment methods.
As a result, the federal governments of many countries are taking another look at digital currencies. Increasing acceptance of digital currencies has also caused their supply to rise dramatically-despite the disastrous bitcoin rollout in El Salvador.
While the growth of digital assets is a welcome development, there are also significant risks for investors, consumers, and businesses. For investors, digital assets are extremely volatile. Last November, the market capitalization of cryptocurrencies was nearly $3 trillion, a record high.
The markets still pose real risks, and sellers often mislead consumers about their value and benefits. In addition, non-compliance with applicable laws and regulations is a widespread issue. Fraud in the digital asset market is also a real concern. According to FBI statistics, monetary losses due to fraudulent transactions for cryptocurrencies rose 600 percent in 2021.
While many people are interested in cryptocurrencies for their financial benefits, this interest may be more about profit than payment. Many cryptocurrencies are extremely volatile, with prices spiking and falling dramatically.
For example, Bitcoin went from a low of US$30,000 in mid-2020 to almost US$70,000 by the end of the year, and then falling to around $35,000 in early 2022. Other rival cryptocurrencies have experienced similarly volatile price movements.
As cryptocurrency has become increasingly popular, global investors are keenly interested in its use. Historically, the traditional financial system has not been very interested in crypto, but this is quickly changing. The interest of big banks to participate in the financial market 2.0 or 3.0 could reverse the relationship in the medium to long run.
Volatility of cryptocurrencies
As cryptocurrencies continue to rise in price, the volatility in the market is likely to remain high. This extreme volatility is evident by looking at historical price charts. For example, bitcoin rose 125% in 2016 and nearly two thousand percent in 2017. Then, after its 2017 peak, it began a steep downward trend.
Volatility in the stock market is largely fueled by news events and speculation. In contrast, volatility in cryptocurrencies is exaggerated by the lack of a robust ecosystem of large trading firms and institutional investors.
This lack of liquidity feeds off of itself, increasing volatility. Most studies of cryptocurrency volatility, however, focus on one particular digital asset, such as Bitcoin, and fail to consider other cryptocurrencies.
Frequency of volatility
Although there are some nuances in this analysis, the overall result shows that the volatility of cryptocurrencies follows the stock market in terms of frequency and magnitude. Although it is difficult to determine how much volatility cryptocurrencies experience on a regular basis, there is a consistent trend. It appears that the first hype of Bitcoin in late 2013 has not had a big impact on the volatility of Bitcoin.
While the GARCH term is useful in predicting the volatility of cryptocurrencies, the sign of the coefficients is not the same for every cryptocurrency. The signs of these coefficients differ by cryptocurrency, but a common trait among them is that they show that the past volatility is persistent. Furthermore, the EGARCH model does not capture spillovers across markets and cryptocurrencies.
As a result, it cannot predict co-volatility.
Although extreme price volatility is rare, it does occur. As investors and traders react to news and market conditions, prices tend to rise and fall. This can cause further volatility. For example, the 2008 Financial Crisis showed a period of extreme volatility. Consequently, investors were forced to place more bets on a continuing trend.
Bitcoin is a very volatile currency. Its volatility is more than five times greater than that of stocks. The SPX measures the performance of large-cap stocks and the NDX tracks the performance of the 100 largest non-financial companies. Bitcoin has a much higher standard deviation than the stock market.
In the United States, cryptocurrency regulation is unclear and ineffective. It discourages investors and entrepreneurs from advancing their projects because they fear being in violation of the law.
This uncertainty drives them to stay away from the market, which hurts the commonweal. In other countries, regulations are less rigid and the markets more welcoming to new entrants.
Nevertheless, some financial services leaders are skeptical about the value of cryptocurrencies, and there are many risks associated with them. One major risk is that they are connected with criminal acts, including the recent Twitter hack.
However, there is also a strong case to be made for cryptocurrencies as an alternative to traditional banking products, such as checking accounts and loans. Moreover, they have the potential to outperform conventional banking products due to their transparency, efficiency, and lack of bureaucracy.
Unstable yet useful
Although cryptocurrencies have a high degree of instability, they are useful for various purposes and add value to the economy. While they are considered highly unstable, regulation would increase the value of crypto-assets and promote their trading on regulated exchanges. While this would contradict the original libertarian rationale of Bitcoin, it would reduce the risks of information asymmetries and moral hazard.
Comparison of cryptocurrencies to stocks
Stocks have long been a popular asset class for people to invest in. They offer both short-term and long-term returns, but are often associated with higher risk and price volatility.
Cryptocurrencies are a relatively new phenomenon, and investors may be less familiar with them.
Yet, both stocks and cryptocurrencies have their own unique characteristics, and they have different benefits and risks. Understanding these differences is vital for new and experienced investors alike.
Who has your back?
While stocks are backed by governments and central banks, cryptocurrencies are not backed by any government or central bank. Cryptocurrencies are entirely digital and do not have an intrinsic value. As such, they are not considered traditional currencies. Investors may feel more comfortable investing in cryptocurrencies due to their safety and security.
Unlike cryptocurrencies, stocks represent a fraction of ownership in a company. Investors can purchase ownership shares to gain partial control of the company. However, only a few companies issue stocks.
This is due to strict regulations, and only a limited number of shares are released. The limited supply ensures that the value of a stock will remain stable. In addition, stocks are often used to raise capital for a business.
Another difference between stocks and cryptocurrencies is the fees involved in trading. A stock trade requires an investor to pay brokerage fees, which can eat into their returns. In addition, stocks require a brokerage account, which requires verification via an address, signature, and Social Security number. While cryptos offer lower transaction fees, they also come with substantial costs. Transaction fees for cryptos depend on the exchange and the type of crypto.
As a result, investors should consider the risks and rewards of investing in cryptocurrencies and other asset classes. While there are some similarities between stocks and cryptocurrencies, you should always be aware of the risks and rewards of each before making a decision.
Jay Speakman is a technology writer based in San Francisco, California. He writes on the topics of blockchain, cryptocurrency, DeFi and other disruptive technologies. Clients include Avalanche, Be[in]Crypto, Trust Machines and several blogs devoted to blockchain gaming. He will not rest until fiat currency is defeated.