I purchased my first cryptocurrency, Wakanda Inu, in 2020. While I had previously owned cryptocurrencies, they were mostly obtained from winning competitions, giveaways and airdrops. So although I had experienced the appreciation and depreciation of tokenized assets all thanks to my collection of free cryptocurrencies, nothing prepared me for the overwhelming sense of trauma that I experienced upon watching my first purchased cryptocurrency depreciate in value disproportionately to what I had initially purchased it at.
I moved on pretty fast, and never really thought about why it happened and how it happened. For all I know the cryptocurrency market is volatile and why is it volatile? Well I didn't really care and I never did until early 2023 – and it happened accidentally. I was researching on a blockchain platform and stumbled upon one single math formula and that was the moment I had one of my major paradigm shifts in both cryptocurrency and math, as I understood the formula better because of cryptocurrency and understood cryptocurrency better because of the formula – THE BIG BANG!
Initially, I felt quite embarrassed. I had been discussing the volatility of cryptocurrency without having a thorough understanding of its underlying mechanics. For the record, I'm not a fan of math, so if I'm getting excited about this, you can bet it's genuinely fascinating. Admittedly, it's not exactly rocket science, and many people might consider it common knowledge, but I only recently grasped the concept, and I'm confident there are still plenty of individuals out there who are unaware. Therefore, the purpose of this article is to shed some light on the subject.
X*Y = K : Introducing Liquidity Pools Almighty Formula
Cryptocurrencies become a tradable asset when they're backed by liquidity. HIVE, for example, can be exchanged with other compatible cryptocurrencies because HIVE has liquidity pools that are filled with said compatible cryptocurrencies hence the moment those liquidity pools are depleted – rekt!
But that's not happening so moving forward, all liquidity pools in the cryptocurrency market are created using the formula X*Y = K. X represents a token, Y represents another token, and their output is represented with K, which is a constant. For example, if a liquidity pool was created with 200 X tokens worth $200 and 200 Y tokens worth $200, then it is permanently established that any change in the X or Y token in respect to their amount (200) won't affect their preset values ($200).
Let's say there are 200 HIVE coins worth $200 in a liquidity pool with 200 Bitcoins worth $200, and you need to swap your 20 HIVE coins for Bitcoin. You head over to a decentralized or centralized exchange built with Automated Market Makers (AMMs) that will execute your swap. You deposit 20 HIVE coins into the liquidity pool and take out 20 Bitcoins. Now there are 220 HIVE coins (X) and 180 Bitcoins (-Y), but remember their preset values ($200) should always be constant (K), so the pool automatically adjusts itself.
Rise And Fall Explained
The adjustment to this liquidity pool facilitated by the swap depreciates the value of each HIVE coin (X) to maintain its rule of constant (K) and concurrently appreciates each Bitcoin (Y) to maintain its rule of constant (K).
This is why my $70 worth of Wakanda Inu dipped to $12, the time at which I liquidated it because nah, I couldn't take it anymore. But maybe if I knew I could take advantage of this it would have been drastically less traumatic, and how would I have done that?
Arbitrage Trading : Understanding Fluctuations and Capitalizing on Volatility
Arbitrage trading is a process whereby traders leverages on the volatility of cryptocurrencies to make profits via the fluctuations of the prices across different exchanges. There are tons of crypto exchanges hence the possibility of slightly different markets on all of them. So, while my Wakanda Inu started depreciating in the exchange I was on, it's likely that another exchange had a slightly higher price. And maybe, just maybe by being fast enough to sell to that exchange and maintaining consistency across other markets, I might have recovered my loss. This practice is termed Arbitrage Trading.
If you're one of those who's thinking,
Buying and selling cryptocurrencies consistently across multiple exchanges to profit off the price differences seems tedious
Well, the good news is there is a solution. Numerous bots and softwares have been created specifically for this purpose. Some of the the best, according to popular adoption amongst cryptocurrency users are Pionex, Bitsgap, 3Commas, Trality etc
However, I recommend you to do your personal research and proceed with due diligence while checking them out and subsequently utilizing them.
Final Thoughts
At a point I realized cryptocurrency and this whole Blockchain stuff isn't as overwhelming and complex as its PR suggests. With little research and a little bit of timing, viola! – your BIG BANG moment.
Understanding what you're involved with will enable you to take advantage of opportunities at any given moment. That being said, if this article has helped facilitate that process for you, leave a comment below!