Cryptocurrencies are a new form of money that don’t need banks or governments to work. They use a technology called blockchain that makes them transparent, secure, and unchangeable.
Many people around the world are excited about cryptocurrencies like Bitcoin and Ethereum because they offer a different vision of how money can work. But if there’s one overriding issue that makes people question their long-term value it’s their propensity for extreme volatility. Crashes of 60% or even 95% are not unheard of in the crypto world and it’s enough to make even the boldest investors approach with caution.
So why do cryptocurrencies keep crashing so hard and so often? To answer this question, we need to understand why crypto gains value in the first place.
What Makes Cryptocurrencies Volatile?
Cryptocurrencies are very volatile, which means their prices can change a lot in a short time. There are many reasons for this volatility, such as:
Supply and Demand
Cryptocurrencies generally have a limited supply, which means they can become more valuable when more people want them. But they can also lose value when people lose interest or sell them.
Market Sentiment
Cryptocurrencies are influenced by how people feel about them. Positive news and events can make people more optimistic and drive prices up. Negative news and events can make people more pessimistic and drive prices down. This influences the demand mentioned above.
Regulation
Cryptocurrencies are not controlled by any central authority, but they are still affected by the laws and rules of different countries. Some countries are more friendly and supportive of cryptocurrencies, while others are more hostile and restrictive. Changes in regulation can have a big impact on the crypto market.
Technology
Cryptocurrencies rely on complex technology that can sometimes fail or be attacked. Hackers, bugs, or glitches can cause problems for the crypto network or the exchanges where people buy and sell them. They can even cause them to outright fail like algorithmic stablecoin Terra UST. These problems can affect the security, speed, or availability of cryptocurrencies and cause prices to drop.
Why Do Cryptocurrencies Crash?
Cryptocurrencies can crash when something triggers a large and sudden drop in their prices. This can happen because of any of the reasons mentioned above, or a combination of them. Some of the common triggers for crypto crashes are:
Market Manipulation
Some people or groups can try to manipulate the crypto market by using dishonest or illegal methods. For example, they can create fake demand or supply, trick other traders, or use insider information to influence prices. They can then profit from the price changes or cause harm to other investors.
Panic Selling
Sometimes, people can get scared or nervous about the crypto market and decide to sell their cryptocurrencies quickly. This can happen because of bad news, rumors, or fear of missing out (FOMO). When many people sell at the same time, the prices can plummet.
Behavioral Factors
Sometimes, people can act irrationally or emotionally when trading cryptocurrencies. They can follow the crowd without doing their own research, or ignore important information that contradicts their beliefs. They can also be too greedy or too fearful and make bad decisions that affect the market.
Technical Factors
Sometimes, the price movements of cryptocurrencies can be influenced by technical analysis. This is a way of studying the patterns, indicators, volumes, and liquidity of the market to predict future trends. Some traders use algorithms or bots to automate their trading based on technical analysis. When these factors trigger a large sell-off or buy-in, they can cause a chain reaction and affect the market.
How Do You Protect Yourself From Crypto Crashes?
Crypto crashes are inevitable and unpredictable. They are part of the nature and risk of investing in cryptocurrencies. However, there are some things you can do to protect yourself and make better decisions:
Do Your Own Research
Don’t rely on hype, rumors, or opinions when investing in cryptocurrencies. Learn as much as you can about blockchain technology, the market, and the regulation of cryptocurrencies. Understand the risks and rewards involved and make informed choices.
Diversify Your Portfolio
Don’t put all your eggs in one basket when investing in cryptocurrencies. Spread your investments across different types of assets, such as stocks, bonds, gold, or real estate. This way, you can reduce your exposure to crypto volatility and balance your risk and return. Always remember that crypto is one of the most risky asset classes.
Have a Plan
Don’t trade cryptocurrencies based on emotions or impulses. Have a clear strategy and goals for your investments. Know when to buy, sell, hold, or exit the market. Stick to your plan and don’t let fear or greed take over.
How Are Crypto Crashes Different from Other Financial Crashes?
Cryptocurrencies are not like other kinds of money that we are used to. They don’t need banks or governments to work, and they use a special technology called blockchain that makes them transparent, secure, and unchangeable.
The crypto market tends to move much faster than traditional finance and the highs and lows are greater. Part of the reason is that crypto is far more speculative than stock-trading, for instance, because there is no underlying businesses for the assets.
What Can We Learn from Other Financial Crises?
Financial crises are not new. They have happened many times in history, affecting different types of markets and assets. Some of the most famous examples are the Great Depression of the 1930s, the Black Monday of 1987, the Dot-com Bubble of the early 2000s, and the Global Financial Crisis of 2008.
These crises teach us some important lessons about how markets work, how risks can spread, and how crashes can affect the economy and society. They also show us some similarities and differences between crypto crashes and other financial crashes.
Some similarities are:
- Both crypto crashes and other financial crashes can be caused by a mix of factors, such as supply and demand, market sentiment, regulation, technology, manipulation, speculation, and human behavior.
- Crypto crashes and other financial crashes can have a domino effect, where one crash can trigger another crash in a different market or asset.
- Crashes in either market can have negative consequences for a large number of investors including retail and institutional (corporate).
Some differences are:
- Crypto crashes are more frequent and more severe than other financial crashes. Cryptocurrencies are very volatile, which means their prices can change a lot in a short time. Cryptocurrencies are also very new and unregulated, which means they face more uncertainty and challenges than other assets.
- Crypto crashes are more isolated than other financial crashes. Cryptocurrencies are not connected to the traditional financial system, which means they don’t affect banks, companies, or governments as much as other assets. Cryptocurrencies also have a smaller market size and a more diverse user base than other assets.
- Crypto tends to bounce back faster. Traditional financial crashes have sometimes lasted decades. Crypto usually crashes hard and rebounds just as hard. There are exceptions, however, as some coins never fully recover.
What Are Some Examples of Crypto Crashes?
Crypto crashes happen all the time. Some of them are more significant than others. Here are some examples of notable crypto crashes that happened in the past:
The Bitcoin Crash of 2018
This was one of the biggest crypto crashes ever. Bitcoin’s price dropped by more than 80% in less than a year, from its peak of nearly $20,000 in December 2017 to its low of around $3,500 in December 2018. The crash was caused by several factors, such as regulatory crackdowns, hacking attacks, technical issues, market manipulation, and investor fatigue.
The Ethereum Flash Crash of 2017
This was one of the most shocking crypto crashes ever. Ethereum’s price plummeted by more than 99% in seconds on GDAX exchange in June 2017, from $319 to $0.10. The crash was caused by a large sell order that triggered a cascade of stop-loss orders and margin calls on the exchange. Flash crashes of this nature are less likely these days as the market has matured with much more liquidity.
Ripple’s XRP crash of 2021
Ripple’s XRP price plunged by more than 60% in January 2021, from $0.76 to $0.28. The crash was caused by a lawsuit filed by the US Securities and Exchange Commission (SEC) against Ripple Labs Inc., alleging that XRP was an unregistered security.
FTX, Terra-Luna, Celsius Crash Crypto in 2022
This is the most recent crash in crypto at the time of publication. It was the culmination of a rip-roaring bull market that started in the middle Covid and ended with numerous crypto companies, including FTX, Celsius and Voyager, going bankrupt. Bitcoin peaked at $68,000 in November 2021 but a little over one year later it was trading at just $16,000. It’s since recovered significantly.
Conclusion: Never Risk More Than You Can Lose
In summary, crypto crashes are different from other financial crashes in many ways. They are more frequent and more severe but crypto also has potential to recover in a relatively fast time frame.
They are also influenced by a mix of factors, such as market volatility, market manipulation, behavioral biases, speculative behavior, technical factors, regulatory influences, and the comparison to traditional financial crises.
The TLDR on crypto crashes:
- Crypto is very risky.
- Crypto crashes can teach us valuable lessons about how markets work, how risks can spread, and how crashes can affect the economy and society.
- Every crypto crash is different but there are starting to be some standard patterns in each crash over the years.
- Crypto crashes can be mitigated by implementing risk management strategies, such as doing your own research, diversifying your portfolio, and having a plan.
