Should we live with market volatility?

No-one can be unaware of the recent influence of Elon Musk on cryptocurrency markets: a tweet in February caused the bitcoin price to soar, then another in May induced a massive correction when he stated that bitcoin’s environmental impact meant he would not use it for payments. The recent BTC revival came shortly after another tweet from Musk. And he’s not alone: in May, Vitalik Buterin moved his Dogecoin holdings which sent the price down 10%.

This disproportionate influence exerted by high-profile individuals suggests that markets in cryptocurrencies are not ‘efficient’. Or perhaps a reflection of the full decentralized market theory not realized. Under the best of circumstances, the decentralized space should demonstrate decisions and conclusions of individuals not just following the advice of one. According to a 1970 theory by economist Eugene Fama, markets are deemed efficient when all information relevant to investment decisions is reflected in the price.

This means that the prices seen on dedicated newsfeeds can be relied on as incorporating all available price-sensitive information – that there is no-one in the broader community in possession of information that will give them an advantage. Such prior knowledge is deemed ‘insider’ – and it is illegal to trade when in possession of it. With crypto, the very ethos of this industry was built on the idea that no single entity or individual had such power.

This year commentators have been vocal about the ‘memification’ of equity markets. Share prices in GameStop climbed more than 1,000% and AMC’s soared 2,600% due to meme-driven buying by younger investors who looked to social media for their trading signals. Groups of retail traders took on the large institutions that usually have pricing power over stocks through the size of their trades, working together to aggregate their efforts to support shares they felt were unfairly undervalued.

The phenomenon of one person – or groups of small players – being able to exert such influence on traded asset prices goes against the idea or ethos of a decentralised market. The fact that influential individuals are able to sway the markets by merely tweeting suggests that the depth and liquidity of even the most-traded cryptocurrencies are insufficient to absorb the resulting high buying activity. The market is narrative-driven – volatility isn’t based on fundamentals, but limited supply and influencers using social platforms like Twitter and reddit.

On a broader level, this phenomenon can be exploited in ‘pump & dump’ scams: groups working in concert to manipulate prices by leveraging the market’s lack of transparency. Some say cryptos will always be volatile – not only are they structurally different to traditional financial markets, but cryptos’ democratised markets enable all participants to have a voice. Investors need to choose who they listen to – and decide on a strategy: buy-and-hold, relying on long-term asset appreciation, or intense speculation: watch the market closely and buy or sell according to predetermined price thresholds.

While ‘buyer beware’ is a reasonable principle for all investors to adopt, clinging too closely to it would confine cryptos to a niche market – hampering the longer-term prospects of the technology. DeFi aims to leverage blockchain technology to bring efficient and customised financial services products to a much wider market. Without the protections that build confidence in the space, it risks failure.

It follows that new markets must find their own new ways of becoming safer. The blockchain industry has its roots in the drive to solve problems and is characterised by its ingenuity. For example, the initiative taken by Solidus Labs to provide machine learning-powered market surveillance shows this principle in action. It is designed to detect, investigate and report digital asset manipulation across numerous crypto exchanges simultaneously and flag any signs of suspicious activity.

Even if crypto market volatility will always be with us, the need for greater transparency fostering trust in the markets will drive innovations to ensure the potential of blockchain technology can be fulfilled. As the market matures, whether it be through solutions offered by the likes of Solidus Labs, or the education of the general public that allows them to realize the true potential of decentralization and trading from what they understand or forming their own opinions through DYOR, we look forward to seeing how the industry will adapt and change.