In a week in which we are yet again reminded how sharply sentiment can shift in crypto asset markets, it’s appropriate to look at the role volatility plays in our narratives, our portfolios and our psyches.
I also want to examine what volatility is not, as its specter takes on a disproportionate influence in times of turmoil.
This confusion is not unique to crypto markets – volatility is misunderstood across all asset groups. As with virtually all market metrics, however, it has particular nuances when applied to our industry.
Setting the table
First, let’s review what we mean by volatility. Technically, it is the degree to which an asset price can swing in either direction. Generally, by “volatility” we mean realized volatility, which is derived from historical prices. This can be measured in several ways – at CoinDesk we take the annualized rolling 30-day standard deviation of daily natural log returns.
Implied volatility represents market expectations of future volatility, as inferred from options prices. More on this later.
The volatility of an asset is an important part of its narrative, especially in crypto markets, which are associated with volatility in the minds of many investors. A survey of institutional investors, carried out earlier this year by Fidelity Digital Assets, singled out volatility as one of the main barriers to investment.
This is because many investors conflate volatility with risk. This is a fundamental investment error that says more about our psychological makeup than it does about our portfolio management insight.
We are, as a species, risk-averse, and have needed to be for survival. This extends to our vocabulary – higher risk also means the possibility of higher rewards, but you don’t hear anyone claim to be reward-averse. “Risk” will forever be associated with something bad, especially when it comes to investments. Investment advisors don’t warn about “upside risk.”
Our aversion to…