By Jonty Sacks – Partner at Jaltech
Surprisingly, many of the factors that influence traditional markets affect the price and volatility of cryptocurrency.
The major difference is that the cryptocurrency market’s volatility is far greater than what’s generally experienced in traditional markets, with some investors experiencing massive gains and/or losses all on the same day. In order to withstand the volatility and reap the benefits, it is important to first understand how the following six key factors affect the cryptocurrency market.
Interest rate adjustments
As with most markets, where a Reserve Bank adjusts interest rates up, the market tends to retract from riskier investments into lower-risk investments as their yields increase making these investments attractive relative to their risk profile.
As such, tech shares and cryptocurrencies are one of the first asset classes to experience a contraction in price when interest rates are adjusted up. The opposite applies when interest rates are lowered.
Demand and supply
Cryptocurrencies, similar to tradable assets, such as stocks, commodities, and securities are influenced by the basic principle of demand and supply. As some cryptocurrencies are limited to a defined number (for instance Bitcoin is limited to twenty-one million tokens) scarcity plays a significant role in price fluctuation. Simply put, as demand for cryptocurrency increases, so will the price increase.
One of the main reasons for the success of many cryptocurrencies is that they solve real-world problems. Take AAVE as an example, AAVE is a protocol that acts as a de facto bank, taking deposits and lending out billions of dollars in tokens to clients within seconds, whilst having no employees on its payroll. Thus, the ability of the protocol to replace a function of a bank will have a huge influence over its investment case and therefore the value of the AAVE token.
Similar to the demand and supply principle mentioned above, the adoption of a cryptocurrency will have a significant impact on its price. Take Walmart and PayPal’s announcement that they will be accepting Bitcoin as a means of exchange or El Salvador legislating that Bitcoin will be accepted as legal tender, these levels of adoption will have an enormous impact on the value of a cryptocurrency.
As with all markets, cycles affect cryptocurrencies. Effectively, a bull market will favour investors and a bear market will erode value. Market sentiment can be measured using the Fear and Greed Index. Based on a measurement of investors’ sentiments towards the market, the Crypto Fear and Greed Index indicates whether the market is bullish (high) or bearish (low).
Another factor that influences a cryptocurrency’s value is a specific event. For instance, media hype around the launch of a cryptocurrency may have a huge impact on trading volumes as speculative investors would want to avoid missing out on the potential of making multiples on their investment, thereby driving the price of the cryptocurrency up.
Other examples include the listing of a cryptocurrency on a major exchange, a regulator announcing an outcome of an enquiry into a cryptocurrency, the launching of a new update such as Ethereum launching a new feature such as proof-of-stake etc.
Although these factors are largely beyond our control , investors can decide on the type of cryptocurrency they invest in. Although short term volatility is probable, an investor looking for sustainable growth should invest in cryptocurrencies that are showing signs of global adoption and are on track to solving a real-world problem.
Ultimately, while all markets are affected by external factors, the key to sustainable growth in any financial endeavour is selecting an investment that has good fundamentals at its core.