What Causes Crypto Market Volatility: How to Mitigate Risk in Volatile Markets

Volatility refers to the frequency and magnitude of price fluctuations for an asset or market. High volatility indicates that the price of an asset can change significantly in a short period, while low volatility suggests more stable and predictable price movements. Crypto assets often experience rapid and substantial price swings, making their volatility a defining characteristic of cryptocurrency markets.

Let's explore the key factors that contribute to crypto market volatility, examine how to measure and assess it, and discuss effective strategies to mitigate risk in this dynamic landscape.

Why is Crypto so Volatile?

1. Market Maturity

While the origins of cryptocurrency can be traced back to the launch of Bitcoin in 2009, the broader cryptocurrency ecosystem only gained mainstream attention around 2017.

Compared to traditional financial markets, which have been established for centuries, the crypto market is still relatively immature.

The comparatively smaller size of the crypto market, with a total market capitalization of around $1.72 trillion as of late 2024, compared to the $107 trillion market cap of domestic equities, makes it more susceptible to price swings. Large trades or investments can have a more significant impact on cryptocurrency prices, leading to increased volatility.

2. Macroeconomic Events

Macroeconomic events, such as geopolitical tensions, economic crises, or natural disasters, can fuel volatility in the cryptocurrency market. Events like these often create uncertainty and fear, leading investors to re-evaluate their risk appetite and potentially withdraw capital from cryptocurrencies.

In the wake of the 2023 Los Angeles fires, the cryptocurrency market experienced a significant dip despite various positive transnational updates. The fires impacted residences and offices of prominent players in the crypto market, including the Santa Monica Bitcoin office, BlockDaemon, and Spring Labs, contributing to a temporary decline in market sentiment and increased volatility.

3. Market Sentiment

Market sentiment, driven by news, social media, and the actions of retail traders, can trigger artificial supply and demand dynamics, leading to significant price movements. In the derivatives market, this volatility can exacerbate short squeezes or long squeezes, amplifying price fluctuations.

For example, negative sentiment surrounding Solana in late 2024 triggered a massive bearish trading movement, leading to increased sell-side pressure. As a result, there was a 90% increase in Solana's circulating supply from 1.54 billion SOL to 4.35 billion SOL, ultimately driving the price down to a 68-day low of $168.

4. Regulations

Government regulations and policy changes can significantly influence the accessibility and perceived legitimacy of cryptocurrencies, impacting trading activity and market volatility. Regulatory actions, such as imposing restrictions on trading, introducing new tax rules, or clarifying legal frameworks, can trigger significant price fluctuations as investors react to the evolving landscape.

For instance, the United States' updated crypto broker tax rule in December 2024, which outlined stricter tracking requirements for digital asset transactions, fueled uncertainty and volatility in the market. The move also strengthened an ongoing legal battle between the SEC and Ripple (XRP), further impacting XRP's price, which had already experienced significant fluctuations in previous years.

5. Supply and Demand

Cryptocurrency tokenomics, which encompasses factors like total supply, distribution, and token utility, can significantly influence the initial supply and demand dynamics. If a project lacks transparency regarding its tokenomics or fails to establish clear use cases and utility for its token, investors may hesitate to invest, potentially leading to lower demand and price volatility.

Similarly, a project's roadmap and future development plans can impact investor confidence and demand. If the roadmap lacks attractive features, partnerships, or utility upgrades, investors may be less inclined to invest, potentially contributing to price instability.

6. Liquidity

High liquidity is essential for stable and efficient markets, as it allows traders to enter and exit positions quickly with minimal price slippage.

Traditional financial markets generally exhibit higher liquidity due to their larger market capitalization, established infrastructure, and diverse participation from institutional and retail investors. In contrast, cryptocurrency markets, while growing rapidly, still have relatively lower liquidity compared to traditional markets. A lower level of liquidity can contribute to increased price volatility, especially for low-cap altcoins or during periods of market uncertainty.

How to Measure Crypto Market Volatility

Understanding and measuring volatility is crucial for making informed trading decisions in the crypto market. Various indicators and tools can help traders assess the level of price fluctuation and potential risks associated with different cryptocurrencies.

What are the Best Indicators of Volatility for Crypto?

Bollinger Bands: Bollinger Bands consist of a moving average and two standard deviations plotted above and below it. The width of the bands indicates volatility, with wider bands suggesting higher volatility and narrower bands indicating lower volatility.
Moving Average Convergence Divergence (MACD): MACD is a trend-following momentum indicator that shows the relationship between two moving averages of an asset's price. A divergence between the MACD and price action can signal potential volatility and trend reversals.
Average True Range (ATR): ATR measures the true range of an asset's price over a specified period, providing an indication of its volatility, with higher ATR values suggesting higher volatility.
Volume: Trading volume reflects the level of activity in the market. Increased volume often accompanies periods of high volatility, while low volume can indicate a more stable market.
Relative Strength Index (RSI): RSI is a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions. Extreme RSI readings, either very high or very low, can signal potential volatility and trend reversals.

Various indices build upon these indicators to provide a more comprehensive measure of market volatility:

Volatility Index (VIX), a.k.a "Fear Index": The VIX, originally developed for the stock market, measures the market's expectation of volatility over the next 30 days. A higher VIX indicates greater fear and uncertainty in the market, often associated with increased volatility.
- Additional Use Case: Can be used as a contrarian indicator, where extreme fear can signal a potential market bottom.
Standard Deviation: Standard deviation is a statistical measure of the dispersion of data points around the mean. In finance, it's used to measure the volatility of an asset's price over a specific period.
- Additional Use Case: Can be used to calculate Bollinger Bands and other volatility-based indicators.
Keltner Channels: Similar to Bollinger Bands, Keltner Channels use the Average True Range (ATR) instead of standard deviation to measure volatility.
- Additional Use Case: Can be used to identify potential breakouts and trend reversals.
Choppiness Index: The Choppiness Index measures the market's trendiness. A high value indicates a choppy and volatile market, while a low value suggests a trending market.
- Additional Use Case: Can be used to filter out false signals and identify periods of consolidation.
Price Rate of Change (ROC): ROC measures the percentage change in price over a specified period. It can be used to identify momentum and potential volatility.
- Additional Use Case: Can be used to compare the relative strength of different assets.

Which is More Volatile: Stocks, Crypto, or Forex?

Cryptocurrencies are generally considered the most volatile asset class compared to stocks or forex. Several factors contribute to this higher volatility:

Nascent Market: The cryptocurrency market is less mature than traditional financial markets, making it more susceptible to price swings and manipulation.
Limited Regulation: The lack of comprehensive regulation in many jurisdictions can contribute to increased volatility and uncertainty in the crypto market.
Technology and Innovation: Rapid technological advancements and the emergence of new cryptocurrencies and blockchain projects can create excitement and speculation, leading to price volatility.
Market Sentiment: The cryptocurrency market is heavily influenced by news, social media, and investor sentiment, which can trigger rapid shifts in demand and supply, contributing to price fluctuations.

Compared to stocks, cryptocurrencies lack the stability and oversight of established regulatory bodies and traditional financial institutions. Additionally, the 24/7 nature of crypto markets, without circuit breakers or trading halts, can exacerbate volatility during periods of high activity or news events.

Meanwhile, Forex markets are more established, with higher liquidity and greater participation from institutional investors, which can help to stabilize prices. Additionally, forex markets’ volatility is more limited to macroeconomic factors and government policies, which tend to be more predictable than the news cycles and sentiment-driven trends that often impact cryptocurrencies.

When is the Crypto Market Most Volatile?

Generally, the overlap of U.S. and European trading hours (12:00 to 16:00 UTC) tends to be the most volatile, as increased trading activity and news flow from these major markets can trigger significant price movements. Asian market hours (00:00 to 08:00 UTC) also tend to experience heightened activity and potential volatility.

Bitcoin (BTC): During U.S. and European trading hours overlap (12:00 to 16:00 UTC).
Ethereum (ETH): During U.S. and Asian trading hours (00:00 to 08:00 UTC and 12:00 to 16:00 UTC).
Binance Coin (BNB): Around major Binance exchange announcements and during Asian market hours.
Ripple (XRP): U.S. trading hours (12:00 to 16:00 UTC).
Solana (SOL): During major decentralized application (dApp) developments or announcements.
Shiba Inu (SHIB) and Dogecoin (DOGE): Meme coins like these often experience volatility during U.S. hours and periods of major social media hype.

How to Mitigate Risk in a Volatile Crypto Market

1. Dollar-Cost Averaging (DCA)

Dollar-cost averaging involves investing a fixed amount of money at regular intervals, regardless of the asset's price. It helps to average out the purchase price over time, reducing the impact of volatility on your overall investment.

DCA can be particularly beneficial in volatile markets, as it prevents you from investing a lump sum at a potentially unfavorable price. By consistently investing over time, you reduce the risk of buying high and selling low, potentially improving your long-term returns.

2. Set Stop-Loss Orders

A stop-loss order is an instruction to automatically sell an asset when its price falls below a predetermined level. You can set a stop-loss order to help limit potential losses by exiting a trade before it incurs further losses.

When setting stop-loss orders, consider factors such as your risk tolerance, the asset's volatility, and the overall market conditions. Placing stop-loss orders too close to the current price might trigger premature exits while setting them too far away could result in larger losses if the price drops significantly.

3. Hedge with Stablecoins

Stablecoins, such as Tether (USDT) and USD Coin (USDC), are cryptocurrencies designed to maintain a stable value, typically pegged to a fiat currency like the U.S. dollar. Hedging with stablecoins involves converting a portion of your crypto holdings into stablecoins during periods of high volatility or market uncertainty.

In doing so, you can preserve capital and reduce exposure to price fluctuations. However, it's important to consider the opportunity cost of holding stablecoins, as they may not generate the same returns as other cryptocurrencies during bull markets.

4. Hedge with Derivatives

Derivatives are financial instruments that derive their value from an underlying asset, such as a cryptocurrency. By hedging derivatives, you can mitigate risk and protect against potential losses. You can hedge derivatives in two ways:

Covered Calls: A covered call involves selling a call option on a cryptocurrency that you already own to generate income from the option premium but limits potential upside if the price of the underlying asset rises significantly.
Protective Puts: A protective put involves buying a put option on a cryptocurrency that you own as a form of insurance, allowing you to sell the asset at a predetermined price (the strike price) even if the market price falls below that level.

How to Trade Cryptocurrencies on Flipster

Sign up for an account on the Flipster website or by downloading the Flipster app (Android or Apple).
Click the [Trade] tab.
Search for your preferred cryptocurrency and click on it.
Select the leverage (up to 100x).
Select either a Trigger Order or Market Order.
Enter the amount of coin you want to trade or choose a percentage of your available funds.
Once you have confirmed the details, click the [Long] or [Short] button to open a position.