As far as the crypto sector is concerned, the current year is not off to a very promising start. This is not the first time cryptocurrency has plummeted. From mid-May till mid-July 2021, cryptos had another significant slump, with Bitcoin falling by more than 45 percent. Regardless of the volatility, some investors remain interested in cryptocurrencies. “As crypto use grows, it will become more stable,” says Vin Narayanan, vice president of strategy at Early Investing.
Bitcoin (BTC), the most valuable cryptocurrency by market capitalization, has lost more than half of its value since reaching an all-time high in November 2021. According to CoinMarketCap statistics, Ethereum (ETH) has also lost more than 50% of its value, and the cryptocurrency market capitalization as a whole has fallen from about $3 trillion to $1.6 trillion at the time of writing. Let us take a closer look at the aspects that contributed to the fall but first and foremost, one must understand the volatility of the market.
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Why is Crypto so Volatile?
Cryptocurrency, in contrast to conventional sorts of investment such as corporate stock, does not have an underlying asset. Its value is not determined by how well a company is functioning, but rather by whether investors predict cryptocurrency will climb or decline in value. That is, swings in the price are entirely dependent on assumptions about how people believe it will perform in the future, rather than actual data. Cryptocurrency could change dramatically in a single day. Several events have produced price fluctuations:
Russias implementing a ban on cryptocurrency activities, Tesla CEO Elon Musk said in May 2021 that the company will no longer accept bitcoin payments because of worries about the environment Or the possibility of Chinese government sanctions on bitcoin trade and mining beginning in June 2021 are some of the negative news impacting on the volatility of crypto.
Not only may bad news influence the market, but positive news might as well. As El Salvador has declared bitcoin to be legal money, Elon Musk said in June that Tesla would likely resume accepting bitcoin payments if more than 50% of the company’s energy consumption is derived from renewable sources also according to reports, Amazon has posted an employment advertisement for a “digital currency & blockchain product lead,” raising the possibility that it would eventually accept bitcoin as payment.
What is Causing Crypto to Crash?
The persistent uncertainty surrounding a new Covid virus, as well as increasing interest rates, which would make it more costly for firms to borrow money, have contributed to a decline in global markets. This has bled over into the bitcoin market, where it has been compounded by concerns about future regulation.
Reasons for Crypto Market Crash
Following are some of the reasons why cryptocurrency prices have crashed:
- Too much leverage by crypto investors: More investors take on risks in the crypto industry, according to CryptoQuant’s BTC leverage ratio as it hit all-time highs in early January. Like in regular markets, crypto speculators often borrow to buy contracts. This could help miners hedge against potential price declines in their currencies. According to eToro’s Simon Peters, this level of leverage “may imply turbulence inside the near term” of crypto. “Long-term investments might be liquidated” in any asset, Peters warns. Prices might fall further if futures investors begin to liquidate their contracts.
- Regulating crypto: In cryptography, a hash number is the rate of computations per second. These computations enable miners to manufacture coins and impact a coin’s price. Prices fall, so does the hash rate. Theoretically, the reverse is also true. This is because miners get compensated in bitcoin. But this also implies that when governments regulate mining, the entire price of cryptos might fall. When China prohibited crypto mining around June 2021, “miners had to relocate,” Peters adds. “We witnessed a big fall in the network hash rate,” crypto investors were told.
- Fear of security breaches: Blockchain & network security are possible causes of a crypto collapse. This collapse would be analogous to government regulation setbacks. For example, if a security hole was discovered in Bitcoin, the motivation to mine it would decrease, affecting the hash rate and total price. There will only ever be a finite quantity of Bitcoin. Unlike stocks, which are backed by assets, most cryptocurrencies are driven solely by investor emotion. It’s difficult to discover cryptocurrencies with limited supply and long-term appeal, says Dan Kemp ( global chief investment officer at Morningstar Investment Management).
- Cryptocurrency stock market correlations: Cryptocurrency should be a non-correlated asset. That is, it should float independently of the market. But not usually. Due to conventional acceptance, crypto markets have gotten increasingly linked with traditional markets. Some believe crypto has a strong link to the share market. So the world’s newest interest rate and inflation hedge may be more market-connected than early users expected. Investors must decide how long they will retain digital assets and if they can withstand market downturns.
- Markets lack liquidity: The largest issue facing the crypto markets when leveraged investors dump huge portions of their holdings is liquidity. There aren’t usually a handful of eager purchasers ready to scoop up unsold coins. This explains why crypto crashes tend to happen on weekends. When a lot of coins are sold, fewer investors are interested. The huge banks can’t trade nickels as they disrupt the markets. For example, selling big sums of crypto by a whale might flood the market. The coins just flow into the market, leaving an excess supply and little demand.
- Vulnerability created by crypto influencers: We’ve seen that with Elon Musk’s backing for Dogecoin. Tweeting might sometimes backfire. Due to market sentiment and crypto’s lack of liquidity, this asset class’s value fluctuates. Stablecoins may be a solution for investors. Traders may use this sort of currency to effortlessly enter and exit other crypto holdings. Peter warns that when it comes to sentiment, “crypto supporters and important influencers may tweet and trigger an influx of cash.”
What should you do?
For a cryptocurrency investor, such sudden price decreases could be very nerve-wracking, particularly when they’re followed by doom-and-gloom news about the crypto market. However, even if that’s the beginning of a lengthy period of low pricing, it does not necessarily imply that crypto is dead. In such a difficult economic climate, the investor should keep the following four points in mind.
Maintain a Long-Term Outlook
Investing in cryptocurrencies is incredibly risky. Looking at the chart of 2021, we can see that there have already been numerous substantial price drops. After each fall, crypto prices finally rose and reached new highs.
Don’t get caught up on the 24-hour statistics. Instead, expand out and check at the year thus far. Ups and downs are a natural component of all market cycles, and they’re more dramatic in the case of a new as well as a relatively untested investment such as bitcoin. You can probably wait out the drops as long as you’ve not invested the money that you want in the short term.
Maintain Your Cool and Avoid Panic
In a crisis scenario, it is logical that the impulse to panic-sell / panic-buy because you believe cryptocurrency is “on-sale” would increase. Everyone prefers to make a profit rather than have their assets’ value half, and it might be tempting you to cut your losses & search for other chances when your investments are losing value.
Panic-selling your assets in a hurry as a consequence of a downturn might result in you losing all you’ve worked so hard for. If the market recovers next week, you will not profit from the increase in value of your cryptocurrency. As panic-buying is concerned, you might believe this is a good moment to purchase the dip. But don’t hurry into it. Look at the market and conduct your research on each coin. To obtain a good deal, consumers can bypass the customary study on a currency or token. Invest only money you could afford to lose. Prices may fall more, so you wouldn’t want to be caught short.
Know that Volatility Is Natural:
There are always downturns in the stock market, and there will be even more downturns in the cryptocurrency market since cryptocurrency is a volatile as well as a high-risk investment as mentioned before.
Having a clear understanding of the risks involved before investing might allow one to be more patient when their investment goes bad. The extraordinary gains that some cryptocurrencies have made as a result of these huge dips are the inverse of these significant decreases.
However, because of the high amount of risk involved, it is critical to ensure that it represents a tiny portion of your overall portfolio and you’ll only invest money that you can afford to give up. Bitcoin’s value has more than halved numerous times since its birth but it has also increased in value virtually every year since that time as well. Take a look at the charts for Bitcoin as well as the cryptocurrency sector to get a better understanding of how this recent slump came about.
Understand Why the Market is Plummeting
Understanding the reasons behind the market’s decline could help you in choosing your next course of action. You can estimate how long it will take for the market to recover.
There are a handful of causes for the recent market-wide drop in the event of the current catastrophe. One reason is investor aversion to risky assets due to the new omicron COVID mutation. Also, the Fed has warned that interest rates may be raised, and there are still rumors circulating about harsher regulation or a hawkish Federal Reserve withdrawing on economic stimulus measures, concerns about increasing regulation, and fear about escalating tensions between Russia and Ukraine.
Develop a Strategy
Now that you’ve assessed the market’s current state, you may determine what to do about it. Remember that buying and holding investment strategy is frequently the greatest approach to generate long-term wealth.
Perhaps you’ve lost faith in crypto and also don’t think it’s a solid long-term investment. Maybe this current price decline has made you realize unpredictable crypto investments aren’t for you. If that’s the situation, you might also want to consider your departure strategy. Selling at the lowest prices in six months is not a choice to be taken lightly. Instead, wait for them to recuperate before selling. Consult a financial professional for advice.
Conclusion
When you witness a crypto collapse for the first time, it might be a confusing experience. Take solace in the knowledge that similar price declines have occurred in the past, and set your sights on the long-term possibilities. While you may be in for a bumpy ride, blockchain technology has the potential to fundamentally alter the way users interact with money. As the trend of digital currency, as well as online trading, continues to attract a large number of consumers, the market will eventually recover its footing. As in a fall scenario, it is important to remain focused and cool to make sound decisions.
