Crypto Volatility: Why Volatility is Important in the Cryptocurrency Market

In the stock market, we have the CBOE Volatility Index (VIX) to measure the market’s projected volatility. According to the CBOE website, the benchmark index is a “30-day expected volatility of the U.S. stock market,” derived from real-time, mid-quote prices of S&P 500 call and put options. The graph shows the performance of two different markets over time, one with high volatility and one with low volatility. In the high volatile market, the line on the graph appears to be very jagged and unstable, with frequent ups and downs that are often quite significant. This indicates that the market is experiencing a lot of fluctuations and uncertainty, and that investors are likely to see a lot of risk and potential reward. On the other hand, the low volatile market appears much more stable and predictable, with a smoother line that shows little variation over time.

This suggests that the market is relatively calm and that investors are likely to encounter less risk and more stability when investing in this market. In traditional finance, volatility refers to the measure of the dispersion of an asset’s price over a period of time. It shows how much a security’s market price fluctuates around its average price. Generally, the higher the volatility, the riskier it is to invest in that asset.

Historically, Bitcoin tends to be the least volatile cryptoasset during bear markets. This is because the vast majority of cryptoassets are technological experiments, many of which will fail. Bitcoin, on the other hand, is battle-tested and has been around for over ten years. Moreover, its relatively ample liquidity, well-known brand, and growing adoption give it the stability that other assets don’t have. With rumors of insolvency and a liquidity crunch circling FTX, one of the largest cryptocurrency exchanges, it’s essential to discuss volatility, how it works, and what it means for crypto markets. With major black swan events now commonplace, asset prices have become more volatile than ever.

In a normally distributed world, both CVX and CVX76 should produce very similar results. We will revisit the differences between CVX and CVX76 when analyzing the empirical data in the following section. A classic example is swing traders in crypto who enter the market at a particular time after measuring the risk. The value of the asset they have measured may go down after they have invested but are never worried because they know that the value will go up in days, weeks, or months. Volatility is a measure of how much the price of an asset fluctuates over time.

If the altcoin’s price has increased, they would receive more of the altcoin and less ETH compared to their initial deposit. This discrepancy between the value of their initial deposit and the value at the time of withdrawal is Impermanent Loss. The cryptocurrency has often been seen as a hotbed for speculation, which induces market instability. Since cryptocurrencies haven’t reached mass adoption, its values is still fueled by hype and speculation. This article explores the concept of crypto volatility and why volatility is important in the growing cryptocurrency market.

This chart shows the annualized and average daily price volatility of selected cryptocurrencies in 2021. 16An overview of all CBOE volatility indices is available at /products/vix-index-volatility/volatility-indexes. 9This case is very unlikely as our intra-day data are collected with a timestamp in millisecond precision.

• Volatility, as a measure of the variability of an asset over time, is the most common risk measure in financial theory.
• Since cryptocurrencies haven’t reached mass adoption, its values is still fueled by hype and speculation.
• This is not an offer, solicitation of an offer, or advice to buy or sell securities or open a brokerage account in any jurisdiction where Open to the Public Investing is not registered.
• Liquidity refers to the ease of buying or selling an asset in the open market.
• One aspect to consider is to carefully select the pools in which to provide liquidity.

Imagine a trader provides liquidity to a token pair pool that consists of equal amounts of ETH and a newly launched altcoin. Initially, the value of both of the paired assets is equal, and they contribute an equal value to each. However, over time, the new altcoin experiences a surge in demand, and its price increases compared to ETH. As a result, the proportion of the trader’s assets in the pool shifts, and they end up with more of the altcoin and less of ETH. This will induce panic and will lead to even more chaos and volatility, given that the cryptocurrency market is easily moved by news and sentiments.

The model-free CVX index should yield a better estimate for markets’ expected volatility than the CVX76. However, due to the assumption of normally distributed log-returns in the Black-76 method, the (CVX-CVX76) spread is an interesting indicator of market implied tail-risk. More specifically, the two indices share the strong statistical bound of cointegration, crypto volatility which is temporarily distorted during heavy-tailed markets. An error correction model shows that said distortions have an average half-life of roughly 17 h. This gives an indication of the time it takes for this market to ‘normalize’. Since the invention of Bitcoin, cryptocurrencies have evolved into a new class of financial assets.

The COVID-19 crisis already showed that cryptocurrencies, despite their delayed response, are subject to systemic volatility shocks. Figure 3 shows the expected Bitcoin volatility in hourly frequency as captured by CVX and CVX76. CVX is the model-free annualized expected volatility over the next 30 https://www.xcritical.in/ days, which is based on mid-prices for Bitcoin options (see Sect. 3.2). CVX76 is based on the Black 76 model implied volatility and interpolated from a volatility surface for each timestamp in the data (see Sect. 3.3). Figure 1 shows the trading volume for different term structure nodes on Deribit.

19We compute the Value at Risk as a quantile of the BTC return distribution. Figure 5 shows a historical simulation (HVaR) and delta-normal (VaR); both methods are standard in the literature and we refer to Jorion (2009) for technical details. 18We account for heteroscedasticity and define negative (positive) tail-events as returns where the standardized residual of a GARCH(1,1) process is below (above) the 1% (99%) quantile. 6Deribit states that “the 12–13 March 2020 extreme market volatility had a big impact on the size of the Deribit BTC insurance fund […].”, prompting several injections to the fund.

The resulting amount is immediately cash settled in the currency of the underlying. For investors and traders, understanding their risk tolerance is always the first step before engaging in any form of investments. Different individuals possess a different level of risk tolerance, and this affects their choice of investments. For instance, a 50-year-old retired pensioner would probably have a very low-risk tolerance since their main priority would be to preserve their wealth. The types of investments they would be looking at would be pension funds, mutual funds, low-yielding government bonds or highly-stable blue-chip stocks that pay-out a sizable dividend income.

Naturally, as cryptocurrency spot markets evolve, markets for derivatives thereon follow. Of those, option markets offer the unique potential to extract volatility information that would otherwise be unobservable. We extract said information through a cryptocurrency volatility index (CVX) that captures the market’s expectation of future volatility. Compared to classical asset volatilities, cryptocurrency volatility dynamics are often disconnected, yet, share common shocks. The results are also similar to the paper on realized volatility from Conrad et al. (2018), where the authors find that equity volatility has a delayed spill-over effect on cryptocurrency volatility.

It is also interesting to point out that males significantly dominate the cryptocurrency market by over 70%. Banking services and bank accounts are offered by Jiko Bank, a division of Mid-Central National Bank. JSI and Jiko Bank are not affiliated with Public Holdings, Inc. (“Public”) or any of its subsidiaries. In the simplest terms, volatility is a mathematical tool or index by which we measure price movements over time for a traded financial instrument or asset.