Why Did Crypto Crash? | Risks of Buying Crypto

This guide will explain what a crypto crash is and what causes it. It also delves into the risks of buying cryptocurrency in a bear market, as well as how crypto holders can invest during a recession.

Crypto market crash explained

A crypto crash is a situation where the cryptocurrency market takes a downward trajectory, with most digital coins falling in value. During such a period, also known as a bear market, major cryptocurrencies such as Bitcoin (BTC), Ethereum (ETH), and other altcoins experience a loss of 20% or more from their recent highs that may persist for days, weeks, or even months.

Steep declines in prices are not something new to the crypto market, as it forms part of the volatile nature of cryptocurrencies. Bitcoin, the pioneer cryptocurrency, alongside a bunch of altcoins, has witnessed significant price declines since its inception in 2009. For example:

November 2011: Bitcoin’s price fell 99% from its previous high;
August 2012: Bitcoin’s price fell 56% from its previous high;
April 2013: Bitcoin’s price fell 83% from its previous high;
December 2013: Bitcoin’s price fell 50% from its previous high in a period of 24 hours;
December 2018: Bitcoin’s price fell 84% from its previous high.

The list above shows how crypto assets are highly volatile and can experience major price swings within the shortest time possible. All the same, from a wider perspective of speculative assets, crypto volatility compares to that of other growth assets like stocks and some of the world’s biggest equities, including Amazon (NASDAQ: AMZN), Meta Inc. (NASDAQ: FB) (formerly Facebook), and Netflix Inc. (NASDAQ: NFLX). Such companies have equally witnessed remarkable price declines at some points.

Crypto beginner’s corner:

Characteristics of a crypto bear market

The following characteristics can help identify a crypto bear market:

Declining crypto prices over a sustained period;
Low investor confidence in the crypto market;
Supply is higher than demand;
Lower highs in case of good news;
Lower lows in case of bad news;
Low coverage of crypto in mainstream and social media;
Growing distrust in cryptocurrency among analysts, economists, and traditional finance stakeholders.

Crypto bear market phases

Bear markets occur in four distinct stages, namely, preliminary, early-stage, full-fledged, and late-stage bear markets. Here’s a description of each phase:

Preliminary-stage bear market

A preliminary bear market sets in after crypto assets reach their peak prices. In this stage, participants maintain optimism about a swift recovery, mainly informed by the immediate bullish period that occurred before the initial pullback.

Early-stage bear market

Significant downside movements, punctuated by recoveries, often characterize the early-stage bear market. In this stage, most market participants may remain hopeful of a new recovery to new heights, which may spur considerable buy-side pressure. However, the recoveries fail to neutralize the downside movements, leading to large red candles and smaller green candles on longer time-frame charts.

Full-fledged bear market

A full-fledged crypto bear market phase is identified by a significant downside, usually with little or zero upside movement across higher time frames. In this phase, some investors may go beyond their denial of an impending drop and start offloading their holdings in large quantities.

There may be some “relief” rallies, but only on shorter timeframes such as one day or a few hours, and most crypto assets may have lost nearly 50% of their values from their previous highs. Significant recoveries are rare, and crypto-allied companies begin to downsize while the market responds poorly to negative news.

A late-stage crypto bear market

A late-stage bear market occurs when the market bottom takes shape, and the downside slows. The period is marked by fewer sellers and more buyers. At this point, the market may be headed for a major correction.

Crypto market outlook 2017-2021

In 2017, the cryptocurrency market witnessed a spectacular rise that saw the value of many digital currencies skyrocket to their all-time highs.

The boom triggered investment haste, as many people perceived it as a new opportunity to make money. However, the boom equally caused notable problems such as frenzy buying, fraud, and cases of hacking, which collectively contributed to the 2018 crypto market crash.

In 2021, the market corrected, and crypto investing seemed to be at its peak. In November of the same year, Bitcoin’s price attained an all-time high of $69,000 as the overall crypto market capitalization hit above $3 trillion.

Crypto market crash 2022

In January 2022, the overall crypto market capitalization dropped to around $2 trillion, followed by a downward trend that corrected slightly in April. On June 6, the crypto market hit a new low of $943.26 billion, according to Statista.

The global crypto market cap was hovering around $972 billion towards the end of September 2022. This means there’s a 50-70% drop in cryptocurrency prices since their all-time highs in November 2021. Some altcoins, including Dogecoin (DOGE), Solana (SOL), and Avalanche (AVAX), have experienced bigger losses, with some losing up to 90% of their values.

In 2022, the price of Bitcoin also fell by more than 50% since its peak in November 2021. Bitcoin commands the largest share of the crypto market, and a decline in its price is more likely to cause the entire cryptocurrency market to lose value.

Altcoins such as Terra (LUNA) and some stablecoins equally experienced massive price declines, which affected their price peg to the US dollar.

The 2022 crypto crash occurred due to multiple reasons, including international geopolitics, the stock market, and the US economy. Besides, the world is adjusting from the pandemic that saw many people invest in the crypto market and its allied businesses.

As the crypto market continues to lose value, crypto-affiliated businesses such as Voyager, 3ac Celsius, and Three Arrows Capital went insolvent, as people lost faith in the market. In the meantime, the values of cryptos kept plummeting, with fewer people investing in crypto trading.

A combination of these headwinds is likely to have caused the crypto crash in 2022, broken down as follows:

The presence of inflation

Many people may have expected cryptocurrencies to remain stable and act as a hedge against inflation, just like gold and other precious metals had done so in the past. Unfortunately, as the dollar’s value suffered from an overheated economy, cryptocurrencies have remained equally unstable in the past six months.

According to the data published by the U.S. Labor Department, the annual US inflation rate has been moving between 8.5% in March and 8.2% as of September 2022. The rising inflation affected the prices of everything from cars and plane tickets to groceries and gasoline. This might have led people to pull their money out of some investments, including cryptocurrencies.

Post-pandemic era effect

The Coronavirus pandemic, which ravaged the world between March 2020 and most part of 2021, most likely triggered people to invest the money they couldn’t spend on traveling, sporting events, concerts, and dining, among others, in other avenues, such as the stock market and other incipient markets, including cryptocurrencies.

This trend could be one of the major contributors to the months-long surge witnessed in the crypto market up to late 2021.

However, it’s also likely that as the world eased into normalcy in 2022, people began to see other options regarding how they could spend their money.

The volatility of speculative assets

Many holders of cryptocurrencies such as Bitcoin and Ethereum see them as alternative investing options to investing in the stock market. This emerging trend could point to people beginning to see cryptocurrencies as high-risk, high-reward assets that somehow may not be suitable investments, especially in times of instability and upheaval caused by global geopolitics and wars.

The Russia-Ukraine war

The ongoing war between Russia and Ukraine is likely to have affected the price of cryptocurrencies negatively. In times of major geopolitical uncertainties, such as what’s taking place in Ukraine, people are likely to shift their investments to proven asset classes that feel safer and more conventional.

Speculative assets such as cryptocurrencies are often more vulnerable, especially if something happens that violently shakes the global economy.

With this in mind, many investors could be weighing the situation in Eastern Europe and the world at large before they can put their money in such avenues.

Understanding a bear market

A bear market can be seen as an eye-opener by some investors because it flushes out malinvestment across different asset classes. For instance, during the dot-com crash witnessed in the 2000s, several internet-based companies closed businesses.

Similarly, during the cryptocurrency boom in 2017, many tokens were launched and traded on various crypto exchanges, only to realize that many of such projects lacked utility and long-term plans for sustainability.

The 2018 crypto market crash caused many such unprofitable projects to close business while legitimate projects and businesses carried through the storm.

A similar situation was replicated in 2022, as projects that could not withstand the storm, such as the ones mentioned above had to whittle down. When choosing investments, investors should research the projects thoroughly and get to know their objectives, including:

What problems are they trying to solve, and how?
Who else is competing in the space?
What work has already been done?
Has it lived through a bear market and survived?
What can you learn about the people involved?

In essence, investing in speculative assets should be informed by the fundamentals and long-term conviction of the projects instead of emotions, mainstream, or social media hype.

Risks of buying crypto in a bear market

When the crypto market crashes, many people can become intrigued and think that it’s the right time to buy crypto. However, there are potential risks of buying crypto in a bear market.

Cryptocurrencies tend to have more ups and downs caused by the amount of hype and ‘Fear Of Missing Out’ (FOMO) involved. In such times, many people would take unmeasured risks. Oftentimes, newcomers enter the market at such times out of FOMO, which may drive them to invest in projects that may not be sustainable.

Importantly, before investing in a bear market, people need to ask themselves what amount of money they can actually afford to lose, as any investment comes with inherent risk.

On the other hand, bear markets can provide potential opportunities for investors who target the long run, as most assets trade at a fraction of their actual values.

How to invest during a recession

While investors can lose money in a bear market, the situation presents a unique opportunity to take advantage of unrealized losses.

Buying the dip through dollar-cost averaging

Investors with reserves of fiat currency, stablecoins, or expendable capital in bank accounts can have the ability to “buy the dip.” Buying the dip is a common phrase used in the crypto space to denote the practice of buying a given amount of cryptocurrency when the market shows a significant bearish correction.

This practice can be profitable if and when the prices come back to their previous or new highs. The most recommended strategy to execute buying the dip is known as “dollar-cost averaging (DCA).” This strategy allows investors to break up their reserve funds into smaller portions and make several trades over time.

Using indicators to identify the best entry point

This method mainly applies to traders and investors with a basic or advanced understanding of technical analysis. They can predict the price of an asset, and analyze indicators and chart patterns to help them determine when an asset has reached a bottom.

While no indicator is completely foolproof, they can provide a strong signal when to buy a dip, especially when using the Relative Strength Index (RSI) indicator. The RSI is a momentum oscillator that comprises a channel and a line that moves in and out of it.

The RSI embraces two key elements:

Overbought: This situation occurs when the indicator line breaks out above the channel. In other words, the asset is considered overvalued and its price is likely to fall back down soon.
Oversold: This situation happens when the indicator line breaks out below the channel. An asset in that case is considered “oversold” or undervalued and its price is likely to rise soon.

These two signals can help users determine which assets to invest in during a bear market.

Note

Other indicators that investors can apply in a bear market are Golden Cross/Death Cross and RSI Divergence.

Diversifying investments across different crypto assets

It’s nearly impossible to accurately tell which of the cryptocurrencies will recover the fastest or proceed to rally the highest. Investors can hedge their bets by using DCA spread in smaller portions across different crypto assets. This is likely to help reduce their overall risk.

When choosing an asset to invest in, the following qualities are worth looking for:

Previous all-time high: Looking at the previous all-time high can give investors an idea of the potential of the asset;
Past history: Tools such as TradingView can help investors gauge an asset’s past performance and see how well it recovered during previous price crashes. While previous performance doesn’t guarantee future price activity, it does give an idea of what could be possible;
Future roadmap announcements: Major updates and roadmap developments could assist in an asset’s price recovery. Investors should consider areas like rebranding, a new partnership, or a mainnet launch.

Avoiding panic

This might look obvious, but managing emotions during a bear market is often not easy for many people. An important step for traders and investors is to recognize that fear and greed are great motivators and can cause them to make rush judgments that might end up in lost trades.

To overcome the two emotional parameters, it’s important to cultivate a concrete plan in mind before executing a trade, as this can make a difference between losing a trade or making a profit. With a proper plan, investors can know when to execute a trade, the amount to use, and when to take a profit.

Maximizing tax-loss harvesting

Tax-loss harvesting refers to a situation where investors sell some of their investments at a loss to offset the gains they’ve realized by selling other assets at a profit. This technique allows investors to reduce their tax bill, given that they are only liable for taxation on their capital gains minus the amount lost.

Final thoughts

The crypto market is highly volatile and price crashes are expected. Investors and traders need to take profits and keep some capital in reserve, which they can use to buy the dip during a crypto market crash.

Traders and investors must also retain composure when bear markets emerge and execute only prudent transactions based on an asset’s fundamentals and long-term outlook.

Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

FAQs on a crypto market crash

What is a crypto market crash?

A crypto market crash is a situation of a prolonged, steep decline in the price of nearly all crypto assets.

What causes a crypto bear market?

A combination of various factors may lead to a bear market. Generally, things such as political crises, pandemics, wars, and slow economies may trigger the beginning of a bear market.

How can investors survive during a crypto crash?

A bear market can scare new investors and most seasoned traders. On the other hand, it presents a unique opportunity to buy crypto assets at heavily discounted prices. Some of the ways of surviving in a bear market include asset diversification, tax-loss harvesting, and using market indicators to identify suitable entry and exit points.

Will crypto crash again?

A crypto market crash has happened before, and it will likely happen again at any time. Investors need to arm themselves with relevant strategies that can help cushion their holdings during a bear market.