Cryptocurrency prices have always been roller coasters, and some rides are scarier than others. However, there may not be much difference in price volatility between the top two coins in the coming months, a key metric indicates.
Implied volatility is the market’s expectation of how risky or volatile an asset would be over a specific period. It is computed using the prices of an option and the underlying asset and other inputs such as time to expiration.
The compression of this spread implies that cryptocurrencies' fortunes are tied more strongly than before to each other. But the force driving them together could be the turmoil in the mainstream financial markets, due to the economic fallout from the coronavirus pandemic.
“The market is macro-driven and does not expect a lot of ‘dispersion’ between the different coins and anticipates a convergence of ether and bitcoin price volatility,” said Emmanuel Goh, CEO of Skew.
Volatility essentially represents uncertainty and has a positive impact on option prices. The higher the uncertainty, the stronger the hedging demand is for both call (bullish bet) and put (bearish bet) options.
However, it does not tell us anything about the direction of the next move. High implied volatility simply means the underlying asset has the potential for big price swings in either direction.
The ether-bitcoin implied volatility differential topped out at a record high of 33 percent on Feb. 22 and has been falling ever since.
“Option-implied volatilities are driven by the net buying pressure for options and historical volatility,” said Lukk Strijers, chief operating officer at cryptocurrency derivatives exchange Deribit.
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Ether and other alternative cryptocurrencies were outperforming bitcoin in February. Bitcoin’s dominance rate, or share of total market capitalization, had declined to a seven-month low of 62.58 percent on Feb. 24.
Hence, it's no surprise that, in February, markets were anticipating a higher ether price volatility compared to bitcoin.
“The increase in investor interest in ether led to a rise in ether-bitcoin implied volatility spread,” Strijers said.
The situation changed in March, as macro factors became the focal point, diverting attention from altcoins to bitcoin – a safe haven from global turbulence, at least according to its proponents, and a benchmark for crypto markets.
However, instead of rising, bitcoin fell sharply in tandem with stocks, as the demand for cash, mainly U.S. dollars, surged amid the coronavirus-led uncertainty in the financial markets.
The bellwether cryptocurrency tanked by nearly 40 percent on March 13.
“The massive drop resulted in a relatively larger increase in bitcoin’s implied volatility versus ether’s implied volatility, causing the spread to narrow,” Strijers told CoinDesk.
In this way, the ether-bitcoin implied volatility differential’s drop to multi-month lows is indicative of a macro-driven market.
Another reason bitcoin faces heightened volatility over the next three months, as suggested by the ether-bitcoin implied volatility spread, is the cryptocurrency’s next mining reward halving, expected in May.
See also: Bitcoin Halving, Explained
A lot has been said about the potential impact on bitcoin’s price of the upcoming 50 percent emission cut. Most experts are of the opinion that the drop in the pace of supply expansion will bode well for the price. As a result, investor interest in bitcoin is likely to remain high compared to ether.
Further, the coronavirus pandemic is showing no signs of slowing down and is threatening to push the global economy into a prolonged recession. Again, the macro uncertainty would keep the focus on bitcoin.