What causes cryptocurrency to crash? This is a question that is on the minds of many, especially when observing the rise, fall, and rise of the value of Bitcoin, Ethereum, and others.
Cryptocurrency shares many things in common with more traditional investments, and while some may prefer to think about crypto as being very separate from that world it’s a mistake to dismiss the similarities. Especially where volatility is concerned.
In May 2022, Coinbase lost half its value in a week. The Coinbase slump amounts to more than $400 million in net losses in the first quarter of 2022 alone. This is a company that made an initial public offering more than a year prior at more than $400 per share. At the time of the Coinbase slump, those shares fell as low as just over $50 per.
Another example; Bitcoin dropped below $30,000 in May, with trading volumes tapering and the value of this cryptocurrency at roughly half of what it was listed for in the fall of 2021. No matter how many HODLers are out there, it’s tough to argue with numbers like these and some wary investors may be liquidating crypto holdings in favor of more safe-haven opportunities.
But why is it happening?
All investments are affected by the larger economic space they’re in. When there’s an economic slump, the whole of the financial industry may potentially be affected. Just because Bitcoin and Ethereum are decentralized, that does not protect these investments from sell-offs, investor panic, and other common features of the traditional financial world.
At the time of the two crashes reported above, the larger world of finance was experiencing its own share of volatility. And that’s a major force to be reckoned with no matter how many HODL investors want you to stay the course. What kinds of factors were at work?
A land war in Europe is one giant reason. The lingering pandemic and the problems it has caused is another. Then there are individual economic conditions on the ground in countries including the USA, Canada, Ireland, China, and elsewhere that may serve to put downward pressure on certain types of investments in general.
Decentralized investments with no regulation or minimal regulation are by their very nature closer to gambling in some respects than investing. When a single person has the power to affect the valuation of a currency with a careless social media post, investors should respect that as a warning sign that stability is not something one should expect in this marketplace.
High returns on investment are typically paired with elevated risk. This is true in crypto and traditional investing. What’s different about crypto? In some cases a lack of context and experience.
Many crypto traders and investors have only recently started buying and selling these currencies and NFTs recently–one source says about half of these investors are at press time not even a full year into their crypto investing journey.
That lack of experience can lead to overconfidence in a type of opportunity that is guaranteed to experience severe lows as well as severe highs. And these newbie investors are more likely to panic and dump their investments at certain signs of trouble.
Remember that FOMO, greed, and fear help drive the forces that create more volatility in crypto. Those are tied to human emotions and emotional investing is the fatal flaw of many a newcomer to this world.
Some people read the above and wonder if crypto is crashing. And by that some mean “crashing forever” and basically dying as an investment opportunity. Under current conditions, that seems as unlikely as the Dow Jones closing its doors for good.
But that assumes that the cycle of investor confidence and investor panic will continue for Bitcoin and others like it in the same way it has done in the past two to three years.
There is no guarantee of this. What could be on the horizon for crypto depends greatly on whether or not the world’s governments and financial institutions continue the more hands-off approach to these virtual currencies or whether the Fed, U.S. Treasury, Internal Revenue Service or other “alphabet soup” federal agencies (IRS, FTC, etc.) get involved in attempts to regulate and control crypto.
We have seen a precedent for this. When China outlawed cryptocurrency across the board, CNBC reported a whopping $400 billion loss in digital currencies and Bitcoin dipped below $30,000 in the same time frame. Don’t expect that to be an anomaly; if other countries ban or severely regulate crypto, a major “market correction” could be in the offing.
And let’s not forget about the elephant in the room for digital currencies. There is no such thing as unlimited growth and infinite expansion. An investment or market trend that grows and grows will eventually experience a contraction or correction.
That’s true of traditional investing, too. Don’t kid yourself that cryptocurrency is somehow different, no investment opportunity can grow indefinitely.
Bitcoin investors might want to think they are different in some ways from their more traditional counterparts. But the advice to both is the same–whether you have bought into a traditional investment approach, decentralized finance, or a combination of both–you need an exit strategy.
You want to set the same limits for crypto as you do for stocks. If the value falls below a level you are comfortable with, your limits will have you selling those investments off to protect you against further losses. Some investments you may buy and hold with the intent of riding out the highs and lows, but where volatility is concerned, buying and holding is a less dependable approach.
If you don’t have an idea under what conditions you would divest of your current digital currency holdings, you are not truly prepared to limit your losses should the market begin taking a downward turn. Decide in advance if possible how far the value can fall before you try to sell. If you have not done this yet, it’s smart to establish that strategy as quickly as possible and stick with it.
Remember, you don’t have to fully divest if things go bad–some do hold a small amount of the currency or stocks just in case. But if you cannot afford to lose even some of your initial investment money, the exit strategy is more critical.
Joe Wallace has covered real estate and financial topics, including crypto and NFTs since 1995. His work has appeared on Veteran.com, The Pentagon Channel, ABC and many print and online publications. Joe is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News.