Factors Affecting the Volatility of Cryptocurrency and Fiat Currencies

 by Elliot Hartridge

Money, or Currencies have been used for millennials to facilitate trade and commerce within countries or settlements. ‘The first known currency was the Mesopotamian shekel which was the first known form of currency which emerged nearly 5,000 years ago’. Before that, many different forms of currencies were used for trade, such as agriculture or even shells. Since then, the use of currencies have constantly been used by humans, and over time, currencies have evolved from physical coins and notes to digital forms, such as credit and debit cards, and even more recently cryptocurrencies. With this in mind, it is certain that the value of currencies in our history and even our future, will never remain the same. This is where ‘volatility’ comes into play. Volatility is the rate at which a currency or stock increases or decreases in value over a certain period of time. Recently, it can be argued that there is a correlation between volatility and risk, as volatility increases, the risk does, and vice versa. Volatility can be used by investors to ‘provide entry points for them to take advantage of’. Of course, it can be determined by many factors, which may be political, economic or social. Over this article, I will be evaluating the factors that affect the volatility of various currencies.

It can certainly be argued that cryptocurrencies are renowned for their volatile nature, and fiat currencies, being backed by governments, can typically be deemed less volatile, however the volatility of each of them can be determined by very similar factors.

Firstly, supply and demand, one of the basic economic principles. In this case, when the demand for a currency increases, the price rises, as it becomes harder to source and buy the currency. On the other hand, if supply is plentiful then price will lower, as there is more of the currency available for purchase. If we look at the supply of Bitcoin, it is clear that Bitcoin is in limited supply, currently there are around 19 million Bitcoins in existence, and there is a total cap of 21 million Bitcoins, after this amount has been issued, it will no longer be possible to mine Bitcoin. With this in mind, it is certain that this supply is limited, this contributes to the large value of a singular Bitcoin and also the volatility it has experienced since the release. In addition to this, the supply is even more limited when other factors are taken into account. Since the release of Bitcoin in 2009, around 4 million Bitcoin have been lost, this may have been due to lost passwords etc. This total value today is nearly £90 Billion. From these various lockups or lost coins, there are only around 8 million coins available, which is illustrated in a pie chart below. In contrast, because the supply of fiat currencies are regulated, this means the supply is not capped, and can remain more regular, reducing the volatility.

Secondly, market sentiment influences the volatility of both currencies. Market sentiment is the attitude that investors have toward prices in a market. Sentiment of investors, just like supply and demand has the ability to change. This may be due to various factors which could include the advertisement of a new coin, or even a celebrity tweeting about one. For example, Elon Musk, owner of Tesla and SpaceX was involved in controversy surrounding DOGEcoin. He has been accused by many investors for purposefully inflating the price of the currency by tweeting things such as ‘No highs, no lows, only dodge’ this rose the price of the coin by 65% in less than 24 hours . This huge rise was due to market sentiment, lots of investors used this tweet as an indication that the price would rise, because of the optimistic viewpoint they had toward the market. This fluctuation in sentiment can change the value or popularity of any form of currency or stock in such a short period of time, the fluctuation of the value of cryptocurrencies may be driven higher than fiat currencies due to sentiment, but the value of fiat currencies can be changed by market sentiment nonetheless.

Regulation, is the processes in which something is controlled and monitored so that it can be maintained and operated properly, regulation is of course another factor that influences the volatility of fiat and cryptocurrencies. If government policies are implemented to reduce the use or trading of cryptocurrencies, their value will drop as the demand for their use decreases. Similarly, if 

Policies are implemented by governments or central banks, such as change in interest rates, this will subsequently affect the value of that country's fiat currency. Higher interest rates will increase the desirability of the investment in that country's currency. Suppose that both France and the UK had the same interest rate, and the British interest rate was to increase by 1%, it would be more favourable to move any money in French accounts into British accounts as the increase in investment will be higher due to the increased interest rate. If a currency's interest rate is decreased, the investment opportunity decreases, this can change the volatility of the currency and lead to a drop in value.

Technological advancements can also alter the volatility of both types of currency. For the sake of cryptocurrencies, if there is a technological advancement which could make trading of sed currency easier, such as an advancement in blockchain technology, this would increase the volatility of that currency as demand would have increased due the fact the currency has become easier to trade. Forex (The Foreign Exchange Market) is a market for exchanging currencies from one country to another , it was first brought online in 1990. This technological advancement has made it considerably easier to trade fiat currencies online, and today the Forex market is the most traded market in the world, which has a daily trading volume of over $6 Trillion. The huge technological advancement in 1990 opened up such a great opportunity for traders online, and certainly influenced and still influences the volatility of fiat currencies, as it increased the demand for the various currencies by increasing the tradeability, similar to how technological advancements that influence cryptocurrencies.

Finally, there are global economic factors to be considered, which again can impact the volatility of both types of currency. It is certain that lower interest rates reduce the value of currencies due to the loss in foreign investment. If an economic crisis was to take place, such as a recession, interest rates would lower as a result of this, impacting the volatility and overall the value of the currency. During the great depression, there was a huge monetary crisis as the supply of money was reduced drastically. In America, from 1929-1931 short term interest rates decreased by 4.25%, with the hopes of stimulating the economy, however it gave the opposite effect, the real interest rate increased due the rate of inflation decreasing at a faster rate, this made borrowing more expensive, and meant households were spending less. Worsening the economic climate, and of course impacting the volatility of the currency. Similarly, with cryptocurrencies, global economic factors have a similar effect on their volatility.

With all these different factors in mind, it is certain that both crypto and fiat currencies are affected by the same conditions, which subsequently affects their volatility. Although, it may be said that cryptocurrencies have a higher level of volatility, these factors listed above certainly strengthens the comparison of the volatility of the two.