How to manage crypto volatility

Volatility is both a blessing and a curse to the investing world. Those who make frequent transactions – for example, day or options traders – may view volatility as a necessary tool to be able to make a profit. Those seeking short-term liquidity may fear the potential loss associated with volatile periods. The first decade and a half of the cryptocurrency space often took traditional definitions of volatility and amplified them, enhancing the potential risks and rewards of the phenomenon.

The novelty of cryptocurrencies and the vast and rapidly changing landscape of cryptocurrencies contribute to volatility, as do shifts in supply and demand dynamics over time, massive speculation, a deeply engaged investor base with a strong sense of fear of missing out (FOMO), and aspects of the structure of the cryptocurrency market itself. Although this volatility can be unsettling, below we’ll explore ways that cryptocurrency investors can stay grounded—financially and emotionally—during it.

What does volatility mean in the cryptocurrency market?

Volatility in the cryptocurrency space is often defined similarly to the world of traditional finance and refers to the degree of variation in an asset’s trading price series over time. However, cryptocurrencies often experience significant price fluctuations – by 10% or more in a single day, in many cases, compared to traditional securities.

Why are cryptocurrencies so volatile?

A range of structural factors contribute to cryptocurrency volatility. Supply and demand is one of the biggest. Bill Shafransky, MBA, CFP, RCIP, senior wealth advisor at Moneco Advisors, noted that the world of cryptocurrencies is “a market of buyers and sellers bidding up and down the price,” contributing to volatility through speculation. Without a company’s “balance sheet or earnings report to reference, it’s really a matter of supply and demand.” This is why external events like a government shutdown, a devaluation of the dollar, or a famous figure in the cryptocurrency world talking about a particular coin can contribute to the rally.

Liquidity plays an important role in cryptocurrency volatility. With cryptocurrency markets open 24/7, and with technology-driven rather than third-party execution, liquidity can be unpredictable. The result may be rapid changes in the price of the cryptocurrency.

Investors typically use leverage in cryptocurrency transactions, resulting in significant gains and losses. In turn, up or down price movements can lead to a chain reaction of investor movements and a larger cumulative shift in prices.

Other elements that contribute to cryptocurrency volatility include external factors such as regulation – or lack thereof – the impact of regulatory uncertainty on investor behaviour, rapid changes in cryptocurrency investor sentiment around the world, and media influence.

How does volatility affect investors?

Volatility may affect cryptocurrency investors in several ways. Rapid price fluctuations can cause significant emotional stress, which can lead investors to succumb to behavioral traps such as panic selling and FOMO. Volatility can also leave investors vulnerable to any number of cryptocurrency-related scams.

Because cryptocurrencies do not have the same legal protections as traditional assets, there is a significant degree of portfolio risk associated with cryptocurrencies as an investment. This risk tends to increase as the allocation to cryptocurrencies within a portfolio increases, and may also be higher for investments in cryptocurrencies with a smaller market cap. However, the size of a cryptocurrency does not guarantee that it will avoid the largest price fluctuations. Take XRP, the fifth largest cryptocurrency by market cap, with a total value of $150 billion. Between November 24 and December 8, 2024, in the space of about a week, the price of XRP nearly doubled.

Land survival strategies

Shafransky noted that sudden price movements in the cryptocurrency market are “a good reason not to put all your eggs in one basket, as the price can turn on a dime and fall dramatically.” No matter what allocation you make for your cryptocurrency holdings, Shafransky suggested that “you have to come to terms with the fact that this investment will fall in value and possibly halve. Just like buying stocks, remember to stay the course.”

Steadfastness in the face of volatility may be easier said than done, and portfolio diversification may be more important in crypto than in traditional investing. Investors should ensure that they hold a well-diversified portfolio of crypto assets – and that their crypto holdings represent a thoughtful part of a larger, diversified investment portfolio as well.

To avoid a knee-jerk reaction to major price fluctuations, consider a tried-and-true investing technique such as position sizing or dollar-cost averaging. Both of these strategies aim to pre-determine investment decisions based on risk tolerance and other factors, removing the emotional element from transactions.

Stop-loss orders are available through many cryptocurrency exchanges and can reduce downside risk during those instances when volatility swings toward losses.

The importance of time horizon and risk tolerance

Cryptocurrency volatility is not necessarily a bad thing, it is just a reality of the industry that must be handled carefully. Mike Casey, CFP, president of AEAdvisors, LLC, suggested that Bitcoin has a unique structural characteristic compared to some other crypto tokens, thanks to its fixed supply. “Other coins will have price gains and losses,” he said, but “Bitcoin’s fixed supply of just 21 million coins…makes it an excellent store of value for long-term holders.” Investors looking at their investments in Bitcoin should not be deterred by short-term volatility, which Casey said is “minimal” compared to the broader gains.

Cryptocurrency investors should regularly conduct self-evaluation to determine their goals. Short-term traders will make different decisions about buying and selling cryptocurrencies compared to long-term holders. Your approach will depend on your appetite for risk, capital to invest, interest in the space, and investment goals.

Bottom line

Volatility is part of the DNA of cryptocurrencies – and learning how to manage it can make investors stronger, not just richer. The goal is not to predict every wave, but to ride it with understanding and discipline. Maintaining a balanced approach through techniques and tools such as dollar-cost averaging, position sizing, diversification, and stop-loss orders can help investors keep their eyes on long-term goals when the cryptocurrency faces short-term instability.