Why is crypto so volatile?

What does volatility mean for crypto?#

Volatility is how much and how quickly a price moves. FINRA describes it as a security, commodity or index fluctuating wildly in a short period of time ^[1], and adds that the more dramatic the swings, the higher the volatility and the potential risk ^[2]. Our volatility glossary entry has the short version.

Regulators use strong words about crypto. The US Commodity Futures Trading Commission (CFTC) says virtual currencies are more volatile than traditional fiat currencies ^[3]. The SEC says investments in crypto asset securities can be exceptionally volatile and speculative ^[4]. The EU's three financial supervisors list sudden and extreme price movements first among crypto's risks ^[5].

How far have crypto prices fallen before?#

In its November 2022 Financial Stability Report, the US Federal Reserve wrote that the market value of selected crypto-assets, excluding stablecoins, was about 69 percent below its November 2021 peak ^[6]. That figure covers a group of selected crypto-assets taken together, not one coin. For comparison, FINRA says a fall of 20 percent or more in a broad market index is generally enough to call it a bear market ^[1].

Some assets fell much further. TerraUSD, a so-called stablecoin worth about $18 billion before May 2022, was wiped out together with the rest of the Terra blockchain ^[6]. Our page on stablecoins tells that story.

Losses and gains are not symmetric: a 50% loss needs a 100% gain to break even ^[7]. In general, a fall of x needs a gain of x / (1 - x), which is plain arithmetic. The chart shows what that means at different depths. The full explanation is on why a 50% loss needs a 100% gain.

Why is crypto so volatile?#

Our sources point to several causes that work together. The table lists each one with the regulator that names it.

Sources: CFTC ^[3], EU supervisors' joint warning ^[5], SEC ^[8] [4], Federal Reserve ^[6].

Take them one at a time. The CFTC says a virtual currency's value is completely derived from supply and demand, which is why it is more volatile than fiat currencies ^[3]. The EU supervisors say many crypto-assets face sudden and extreme price moves because their price often relies solely on consumer demand ^[5]. The SEC says trading in bitcoin and ether has been substantially driven by speculation, which can lead to heightened volatility ^[8], and the Federal Reserve called speculation and risk appetite the primary driving forces of crypto prices ^[6].

Market structure adds to it. The EU supervisors list market manipulation, lack of price transparency and low liquidity as risks ^[5], and the SEC cites volatility and illiquidity in crypto markets ^[4]. FINRA explains, for securities, that a large order in a low-volume market is hard to execute quickly ^[9].

The first two steps come from a Bank for International Settlements (BIS) study of 95 countries: when the bitcoin price rises, more people download and use crypto exchange apps ^[10]. The last two follow the EU supervisors' point that prices often rely solely on demand ^[5]. Chasing what already moved has a name; see fomo trading.

What can volatility do to a beginner's money?#

Swings in both directions also cost money on their own. A rise of x% followed by a fall of x% leaves you with a loss ^[7]: $1,000 up 20% is $1,200, and down 20% from there is $960 (calculated). The bigger the swings, the bigger this drag.

The outcome for real people has not been good. A BIS study of crypto app use in 95 countries from 2015 to 2022 estimated that 73-81% of retail investors had likely lost money on their initial bitcoin investment ^[10]. The same study found that new users arrived when prices were rising ^[10].

Why does leverage make crypto volatility more dangerous?#

Leverage means controlling a position larger than the money you put down. The CFTC warns that crypto's volatility is amplified in margined futures, and that traders hit by a move may be forced to refill their margin or close their positions, and may in the end lose more than they put in ^[3]. See leverage and margin explained before you go near it.

Before fees and funding costs. A loss above 100% means owing more than you deposited. Before that point you may be forced to add money or have the position closed ^[3].

How can a beginner limit the damage from crypto volatility?#

Nothing removes the volatility itself. What you can control is how much of your money is exposed to it and whether you are forced to sell at a bad moment.

1. Use only money you could lose entirely

   The EU supervisors' first question is whether you can afford to lose all the money you invest ^[5]. The FCA says to be prepared to lose all your money ^[11].

2. Keep the amount small

   Decide the most you are willing to lose before you buy. Our position sizing guide shows how to turn that into a number.

3. Skip leverage

   Leverage amplifies crypto's swings into bigger losses and can cost more than your deposit ^[3].

4. Think about spreading purchases over time

   FINRA says dollar-cost averaging can help limit losses in big declines, but often produces lower returns than investing a lump sum and can mean more fees ^[12]. FINRA writes about investing in general, not crypto. Try the dollar cost averaging calculator.

5. Write your plan down before the price moves

   Decide in advance what you will do after a 20%, 50% or 69% fall. A plan made in calm conditions is easier to follow than one made during a crash.

Mistakes beginners make with crypto volatility#

• Buying because the price just went up

  The BIS found that rising bitcoin prices pull in new users ^[10], so many buy after a large rise has already happened.

• Thinking a big fall means it must bounce

  A 69% fall needs a 222.58% rise to recover (calculated). Some, like TerraUSD, were wiped out instead ^[6].

• Adding leverage to a volatile asset

  At 5x, a 20% move takes all of your money (calculated); the CFTC warns you can lose more than you invested ^[3].

• Assuming crypto is protected like a bank account

  Crypto in the UK is largely unregulated and FSCS cover is highly unlikely ^[11]. In the US, crypto accounts do not get SIPC or FDIC type protections ^[4].

Frequently asked questions#

The bottom line#

Crypto is volatile because its price rests on demand and speculation, in markets that are often thin and lightly regulated. The Federal Reserve's 69% figure shows how deep a market-wide fall can go, and the arithmetic of recovery shows why such falls are so hard to undo. Keep the amount small, skip leverage, and decide your plan before the next swing. Then use the drawdown recovery calculator and read our risk disclosure.

Education only. This page is not investment, tax or legal advice. Trading and crypto can lose you money. See our risk disclosure.