Here's Why Crypto Is So Volatile

Cryptocurrency is a rapidly-growing industry. This is not breaking news. I’m sure you’ve heard both sides of the story: crypto has made kings and queens... and paupers. But those wins and losses don’t necessarily come from the winners picking good coins and the losers picking bad ones. It’s possible to talk to two people who have both invested in Dogecoin, but one lost money and the other gained a profit. Whether you win or lose can depend largely on timing. This is because cryptocurrency is an incredibly topsy-turvy investment; all cryptocurrencies experience huge fluctuations in their valuation—a quality known on Wall Street as volatility. Cryptocurrency is an incredibly volatile investment. In one day, Bitcoin’s value dropped 30%. But…

This question brings up something that we often forget with cryptocurrency: it isn’t intrinsically valuable. There isn’t gold or diamonds or salt or anything backing up crypto’s value. At no point did the U.S. treasury say, yes, any time someone wants to bring us Bitcoin, we will give them X number of dollar bills from our reserves. No, crypto’s value comes from how much people are willing to trade for it—in goods, other cryptocurrencies, or in dollars.

There are prospective investors that are interested in crypto not to use it as a currency, but to use it as a hedge against inflation. But without anything intrinsically valuable backing up the currency, crypto’s market value is based entirely on speculation, which is essentially educated guesswork.

Investing in something that is speculative is a guaranteed way to introduce volatility in your portfolio. It means the investment’s value isn’t very grounded, which makes its price incredibly sensitive to even slight changes in investors’ expectations or perceptions.

Think of it like visual art. Say you are at a fancy gallery, and there are two statues made by twin artists that everyone is buzzing about. One twin made a shiny, gorgeous statue made of 50 pounds of gold. The other twin’s statue also clocks in at around 50 pounds, but it’s made of sand and cardboard. Gallery-goers flock to these two pieces equally because the twins are really big deals in the art world. The twins have been pictured lately laughing over coffee with Anna Wintour, ice skating with Bernie Sanders and joyriding with Kylie Jenner. Suffice to say, the sculptors are big freakin’ deals and everyone’s fan boy/girl-ing over them.

At the gallery, both pieces are valued at the same price; let’s say they’re both priced at around $2 million, just to put a big, fun number on it. Then, drama alert! It's discovered that both of these twins are big frauds. All the photos were photoshopped: Anna Wintour has never heard of them, Bernie was out of town and Kylie Jenner doesn’t even follow them back on Instagram. *Gasp.*

As you can imagine, art collectors stop buzzing about these artists, and the gallerist knows that he needs to slash the price of the sculptures down. For the gold statue, popularity is no longer adding value to the price. However, the statue is still made out of gold, so it’s still worth something. The gallerist obviously wouldn’t slash the price of the sculpture for less than the value of the raw materials, because, at the very least, some jeweler may want to buy the piece if only to melt it down into gold for necklaces (that are actually Vogue-approved). 50 pounds of pure gold would probably clock in at $1.5 million— which is certainly a price drop from the $2 milli the sculpture was once worth, but still a valuable piece. For the twin who made their piece in the sandbox, however, if the gallerist were to price the piece at the cost of the raw materials, that price would drop to a big fat $0. A value drop from $2 million to $0? That’s a long way to fall.

Cryptocurrency is in the same boat as the sandy statue: it’s not intrinsically valuable. Not everyone would agree with this conceptualization, but I would say that cryptos’ value really comes from how much money (in dollars) people are willing to spend to get their hands on it. Because crypto has no intrinsic value, like the sand and cardboard statue, its value is very sensitive —and extremely reactive to news and opinions. It’s essentially like a hot air balloon ride: you might enjoy the view from the top, but once you realize you’re only suspended by hot air, you’ll wish you could get off the ride without falling. Unfortunately, in the case of speculative investments, oftentimes what goes up, must come down.

For example, Vox has a fascinating graphic on “The Musk Effect,” or the phenomenon of how strongly the value of Bitcoin is affected by Elon Musk’s tweets. If it makes you nervous that one person’s Twitter account has a huge influence over the value of your investments: good. It should. Having the value of your investments be at the whim of one person’s fickle opinion, that you have no control over, sounds like a huge risk to me. That is risky. It kind of reminds me of the time when one person’s Twitter account had a huge influence over the state of the union, if you catch my drift.

So, before you decide whether you want to invest in crypto, you need to know if you’re up for the bumpy ride. Earlier I referenced a day where Bitcoin’s value dropped 30% in one day. Can you imagine losing 30% of what you have in your bank account in one day? If that mere thought made you sweat and break out into hives, cryptocurrency may not be a good investment for you.

xo,

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