Why cryptocurrency market (and all new emerging asset classes) are volatile and quite speculative?
Such environment shapes opportunities for huge gains and, unfortunately, losses too.
Before I dive deeper into the topic I want to acknowledge you that this entry was inspired by reading Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond book by Chris Burniske and Jack Tatar.
If you want to bolster your knowledge about investing in cryptoassets, then you would do so by reading this book.
Each asset class has its own economic characteristics. Cryptocurrencies are unique in that matter since their characteristics of governance, supply schedule, use cases and basis of value are varying from each other.
For example, you can’t say that Ethereum is the same as Bitcoin even if they both make use of cryptography and are blockchain-based assets. There are cryptocurrencies (bitcoin, litecoin), cryptocommodities (ether, lisk) and cryptotokens (like REP token that values reputation on Augur system that was built on top of Ethereum platform).
It’s an emerging asset class and it’s hard to strictly describe it.
That’s why you should always investigate the monetary policy of any cryptoasset before throwing your money into it. Make sure it makes sense in the long-term perspective.
Okay, so why they are so volatile?
That kind of assets is priced by market dynamics of supply and demand.
Cryptoassets’ value is determined by two components:
I believe the best way to describe this component would be to quote a fragment from the book (yes, I was too lazy to describe this in my own words and it was also too well described already):
Utility value refers to what the underlying blockchain is used for, and therefore what the demand is for its asset. For example, Bitcoin’s blockchain is used to transact bitcoin and therefore much of the value is driven by demand to use bitcoin as a means of exchange. Similarly, bitcoin can be used as a store of value, so a percentage of the bitcoin outstanding is demanded for that use case. All these use cases temporarily bind bitcoin, drawing it out of the supply of bitcoin outstanding. The more that people want to use bitcoin, the more they’ll have to pay to get access to it.
from Chapter 8: Defining Cryptoassets as a New Asset Class
Cryptocurrencies’ age is under decade old, we can’t say how most of them will develop. This is where the speculation comes to play.
Speculative value is defined by people trying to predict future adoption of an asset. It’s cooling down as asset’s certain maturity or milestone is reached.
The younger cryptoasset is, the more speculative capability it has. Other than that what also has an impact is the development team. People tend to trust and believe in team’s vision if they seem to be legit and genuine with the community.
This chart below presents how utility value grows over time and speculation diminishes.
A good example to quote in my opinion is EOS.
EOS’ platform is under development so it doesn’t exist yet. But people are speculating on its price (and vision) pretty heavily. Over $2 billion of market capitalization is quite huge I must admit.
I wish I knew all the things that I write here before so I wouldn’t sell my EOS tokens with a loss so easily. Now I’d have to buy them multiple times more expensive. A priceless lesson for myself.
To summarize my post I’d quote this informative fragment from the same book:
Benjamin Graham uses a famous example in his classic investing book The Intelligent Investor, where he personifies the market as Mr. Market, who is prone to oscillation between dark and ebullient moods. When Mr. Market is dark, he’ll throw assets around, damaging their value to beneath their utility value. When Mr. Market is ebullient, he’ll pay most any price for assets, driving them far above their utility value with hefty speculative premiums. Mr. Market is a fictional representation of the movement of crowds, and Graham suggests that investors do their fundamental work on the asset and from there ignore the moods of Mr. Market.
Stay aware traders & investors as well as don’t let your emotions overcome your wisdom!