What happened

Volatility, thy name is crypto.

As of 11:30 a.m. ET Friday, the values of a couple of the best-known and most widely owned cryptocurrencies -- Bitcoin (BTC 2.63%) and Ethereum (ETH 1.65%) -- were finally bouncing back a bit after days of declines. The 6.8% rise in Bitcoin and the 8.7% rise in Ethereum over the prior 24 hours, however, stood in stark contrast to the continuing troubles of stablecoin TerraUSD (USTC 1.86%), which is down 64.5% currently -- and was down by as much as 99.9% earlier in the day!

Round Bitcoin overlaid on a falling stock chart.

Image source: Getty Images.

So what

So what the heck is going on with crypto now? Here's my read on the situation:

This week, crypto investors got a loud wake-up call about the depths of the risks inherent in these assets, and a demonstration of just how dependent their values are upon investor sentiment. Crypto prices rest on confidence. As investors rapidly lost that confidence in the values of tokens, holders of virtual currencies saw more than $600 billion of their wealth disappear into thin air over the past week. Bitcoin in particular lost as much as 27% of its value, and Ethereum dropped by almost precisely 33.3%.  

In contrast to bonds, which are contractual agreements to pay known-in-advance interest, or stocks, which represent ownership stakes in real businesses that (in theory, at least) do things to earn profits over time, buying a cryptocurrency is more akin to buying gold or silver. A crypto investment is only worth what investors think it's worth -- only what they're confident they will be able to resell it for.

Now what

Now, the good news is that Friday's modest bounce-back in crypto prices suggests investors may be regaining some confidence in crypto -- but I think that's a misreading of the situation. The way I see it, Friday's uptrend has the earmarks of a move driven by investors who lack confidence in an asset, but who are nevertheless closing their short positions to lock in their winnings just in case they're wrong. Specifically, we've seen huge declines in price in a short period of time, followed by significant bounces on no particular good news other than the price movement itself. Indeed, far from good news, we're seeing pundits on Coindesk.com and elsewhere predicting that volatility in crypto may "continue to play out in the weeks to come."

Friday's bounce also has the feel of investors rushing in after a sell-off to "buy at the bottom," on the assumption that Bitcoin and Ethereum (and other cryptocurrencies as well -- many other second-tier tokens by market cap are bouncing by significantly higher percentages than the big names) will naturally return to the higher prices at which they once traded. And in that regard, it makes sense that investors who decide they still want to own crypto would favor established names like Bitcoin and Ethereum, and avoid more exotic names like TerraUSD -- especially now that such stablecoins have proven themselves anything but stable. (Or even usable. The reason TerraUSD in particular is down so much Friday is that on Thursday, the Terra blockchain network automatically shut down temporarily because, as Terraform Labs explained, the price of Luna tokens had dropped so low that it was unable to "prevent governance attacks." That shutdown for a time prevented transactions in the algorithmic stablecoin.)  

Of course, when you get right down to it, this all just reinforces the theory that investors' confidence in crypto is the biggest thing supporting token values. And given how much that confidence has been shaken this past week, I'd expect we'll see volatility in crypto prices for some time to come.