Brace for Impact: A Guide to Navigating a Cryptocurrency Crash in 2023
[TL; DR]
🔹 A crypto crash occurs when the price of a cryptocurrency falls by 10% or more within 24 hours.
🔹 Bitcoin and other cryptocurrencies experienced many crashes before 2022.
🔹 In 2022, the war in Ukraine, FUD, rising interest rates, limited liquidity and market manipulation were contributing causes to cryptocurrency crashes.
🔹 The key things to do during a crypto crash include being calm, holding on to your cryptocurrency and maintaining a long term investment perspective.
Introduction
2022 has been the worst year in the history of cryptocurrency as a result of several severe crypto crashes. The year started badly due to the increase in inflation in many countries of the world including the United States. In response, some of the countries resorted to hiking interest rates in an attempt to curb the rising inflation. The correlation between cryptocurrencies and the stock market means that the effects of volatility in the stock market affect the cryptocurrency market as well.
Causes of crypto crashes in 2022
There is no doubt that 2022 had devastating market crashes that reduced the confidence that people had in cryptocurrencies. The causes of crypto market crashes are many and several of them were at play in 2022. Some of these are macroeconomic factors like rising inflation, Russia’s invasion of Ukraine, the correlation between the stock market and cryptocurrencies as well as market manipulation.
To start with, let’s understand what a cryptocurrency crash is. A crypto crash is a sharp and sudden decrease in the price of a cryptocurrency. Basically, it refers to a 10% or more fall in the price of a cryptocurrency within 24 hours. The main causes of crypto crashing include breaking news that affect economic conditions and other major negative global developments like outbreaks of wars or pandemics.
Correlation between the equity market and crypto market
The crypto market is correlated to the stock market. As a result, any downtrend that occurs in the equity market is likely to spill over to the crypto market. In fact, the correlation between the crypto market and the stock market was observed in early 2022, soon after many governments relaxed Covid-19 lockdown measures.
For example, at the end of 2021 to early 2022 the prices of cryptocurrencies followed the trend of the stocks. They rose when the price of stocks increased and vice versa. What this means is that the macroeconomic variables affect cryptocurrencies and stocks at the same time.
Rising interest rate
Rising interest rates have been the major reason why cryptocurrency crashed in 2022. As a fact, the entire year was bearish due to persistent increases in inflation and interest rates.
The reality is that after the pandemic, many countries including the United States, have been experiencing rising inflation. In order to reduce this rising inflation some of the countries, including the United States, hiked interest rates. Also, rising interest rates depressed the global economy which reduced liquidity in the crypto market.
Although some other factors contributed to the crashes of Terra USD and the collapse of FTX, the depressed global economic situation indirectly contributed to that. Basically, persistent hikes in interest rates by the United States forced many investors to sell off their cryptocurrencies which reduced their market capitalization, making them prone to crypto crashes.
Limited utility
Another cause of the crypto market crash is the limited utility of some cryptocurrencies. This is because coins and tokens with minimal utility face liquidity challenges during bearish crypto markets, such as the one we experienced in 2022. It is most likely that low liquidity and minimal utility contributed to the crash of LUNA and FTT.
The point here is that cryptocurrencies that do not have many compelling real-world uses face liquidity challenges during bear markets. The reason is that there is no sustained demand for such tokens or coins.
Also, cryptocurrencies that have large market capitalization, such as ETH, BNB and BTC are unlikely to crash during bear markets. That is why these are the cryptos to buy now. The cryptocurrencies that will survive the current bear market will be the best investment assets for years to come, unless other extenuating circumstances arise.
Fear, uncertainty and doubt
Fear, uncertainty and doubt (FUD) is another key cause of the crypto market crash. The main cause of FUD is news that indicates possibilities of a slump in prices of many cryptocurrencies.
Once FUD grips the market many investors may opt to sell their cryptocurrency. For instance, the news of Russia’s invasion of Ukraine resulted in a general drop of prices of many cryptocurrencies. This is because the invasion resulted in rising prices of many commodities such as certain food stuff and fuel. As a result there was a general reduction in the buying power of many would-be-investors.
In the end, some crypto investors sold their cryptocurrencies in order to augment their incomes. Also, negative news about a specific cryptocurrency or blockchain projects may directly lead to cryptocurrency crashes. For instance, the leaked information about FTX resulted in its collapse.
Cascading crypto sell offs
Using borrowed funds in trading is one main cause of crypto crashing. There is margin debt or margin trading when traders borrow funds from brokers for the purpose of trading.
The investors who borrow funds to purchase cryptocurrency enhance their chances of earning higher profit than otherwise. However, they can also make huge losses. Generally, the traders who use high leverage are at a big risk of liquidation should the price go the opposite direction.
Therefore, if many traders have high leverages and the price of the asset falls they all face liquidation. Too much liquidation on a trading platform can trigger a sharp fall in the price of a specific cryptocurrency. As many other traders see the sharp decrease in its price they can close their positions. Such a sell off may cascade through the market leading to a crypto crash.
Market manipulation
Cryptocurrency falling may be a result of price manipulation in the market. Some investors may choose to spread FUD in the market to force the price of a cryptocurrency down.
Large groups of investors who hold large quantities of cryptocurrencies (whales) may connive to conduct coordinated sell offs of cryptocurrencies. This can lead to sharp and sudden falls in their prices resulting in market crashes.
Notable events and crypto crashes
Several events occurred in 2022 that caused crypto crashes. In some instances, the crypto crashes that took place were a result of more than one cause. Nevertheless, in other circumstances there were chains of activities that ultimately ended in crypto crashes.
War in Ukraine
The war in Ukraine was one of the events that contributed to some crypto crashes. First, the war resulted in shortages of important products such as wheat, fertilizer and fuel. Specifically, following Russia’s invasion of Ukraine in February 2022, there was shortage of gas and fuel in Europe. This caused increases in the prices of these commodities.
When prices of products which the people mostly depend on increase, the consumers spend more money on them than before. As a result, their disposable income decreases which impact their investment patterns. In fact, some stop investing in risk assets like cryptocurrencies. On the other hand, others sell their current investment assets in order to supplement their income.
Another effect of the war was the fear of a global recession. In some cases, geopolitical conflicts can lead to economic crises. As such, the fear of the recession after Russia’s invasion of Ukraine forced many people to sell their cryptocurrencies and stocks. This contributed to the emergence of the crypto winter.
Basically, the tension that arose from the invasion of Ukraine led to the fall of the global crypto market by over 10%. Within 24 hours after the invasion the price of ETH fell by 12%, that of Solana by 12%, Avalanche by 18.2%, Cardano 18%, Shiba Inu 18.9%, Dogecoin 16.7% and Polkadot by 16.2%. In fact, the price of most major cryptocurrencies fell by similar margins.
The FTX crash
Apart from Russia’s invasion of Ukraine, the implosion of the Terra USD and Luna as well as the collapse of FTX contributed to the crypto winter of 2022. In fact, these events created panic and fear in the crypto market. This is because many people lost their entire investments. For example, some investors had invested their entire life savings in FTX.
There was a trail of events which led to the collapse of FTX. These include the leaked confidential information of FTX’s investment of a large quantity of its native token, FTT, in its sister company Alameda Research. Thereafter, Binance sold its large FTT holding which created a panic in the market. What followed was a mass sell-off of the FTT coin and other cryptocurrencies on the FTX exchange which led to its collapse.
Also, it was very easy for the crypto exchange to collapse since about 93% of the FTT tokens were held by only 10 wallets. Therefore, there was a high possibility of market manipulation.
Did crypto crashes occurred before 2022
The truth is that before 2022, there were other major crypto crashes which include the Crypto Black Thursday. Another notable crash occurred after the closure of the Bitfloor exchange in 2013.
Crypto Black Thursday
On 12 March 2020, the World Health Organization (WHO) declared Covid-19 as a global pandemic. As a result, many countries like the United States announced measures to curb its spread. These developments created panic among investors who responded by mass sell-offs of cryptocurrencies and other securities.
Following the declaration, the price of BTC fell by over 40%. That crash was not a big surprise since Asia, with many crypto investors, was hard hit by the pandemic.
Bitfloor shut down
Another serious BTC crash occurred in 2013 after the US Financial Crimes Enforcement Network (FinCEN) shut down Bitfloor, a prominent cryptocurrency exchange. The price of BTC fell by over 70% since it decreased from $260 to $70. Following this event, Bitcoin only recovered after 6 months.
The risks of buying cryptocurrencies during a crypto collapse
Many investors do not want to purchase cryptocurrencies during a crypto crash owing to potential risks. The greatest risk is that of price volatility. During a crash the price of most cryptocurrencies may fall more than anticipated leading to many losses.
Fear, uncertainty and panic exacerbate the effects of a crash as many people tend to sell their holdings. Experience of what happened in recent crypto crashes shows that even some patient investors tend to sell their cryptocurrencies during periods of the crashes. This may result in the implosion of some cryptocurrencies and the collapse of crypto projects.
The graph above shows the implosion of TerraUSD that occurred on 9 May 2022.
What to do during a crypto collapse
After discussing the causes of crypto crashes, let’s find what we can do during such periods to protect our investments.
Hold on to your cryptocurrencies: The best thing to do is to hold on to your cryptocurrencies rather than selling them under pressure. When you sell them under pressure you often incur losses. As long as you do not sell the cryptocurrencies at prices that are below the ones you purchased them at you do not make any losses.
Manage your emotions
The key thing to deal with during a crypto crash is to manage your emotions. You have to remember that markets are cyclical and corrections and crashes often happen.
Maintain a long term perspective
It is important that you view crypto investment as a long term thing. With that, you will remember that after any dip in the crypto market a rebound will occur. The key point here is never to focus on 24 hour charts since they can increase your fear and panic. Instead, look at long term price fluctuations.
Consider buying the dip
Crypto crashes can present opportunities for investors to buy the cryptocurrencies when the prices are very low. As a result, they will make huge profits when the market makes a rebound. Therefore, buy the dip during crypto crashes.
Reassess your financial strategy
There are things you need to do before cryptocurrency falls. It is important to diversify your portfolio. This involves buying and holding different cryptocurrencies which will reduce the risks if some of them experience crypto drops.
Dollar average costing is another important strategy when acquiring cryptocurrencies. This involves using a fixed amount of money to buy cryptocurrencies within specific periods. Most people purchase the cryptocurrencies weekly or monthly when they have different prices.
Conclusion
The crypto sector, just like the stock market, experiences market crashes from time to time. Some causes of crypto market crashes are negative global events like wars and pandemic, macroeconomic instability, manipulation of the market and FUD. The Crypto Black Thursday and the Bitcoin crash due to the closure of Bitfloor are examples of market crashes that occurred before 2022.
FAQ
Will crypto recover from a crypto crash in 2022?
Crypto is likely to recover from the market crash that started in 2022. However, the possibility of recovery depends on other factors such as the stabilization of inflation rate and interest rates. If the Federal Reserve stops hiking interest rates the crypto crash may end. However, the crypto winter will continue in the first quarter of 2023 but may recover in the second quarter.
What crypto coin will explode in 2023?
Several cryptocurrencies have the potential to explode in 2023. Generally layer-2 cryptocurrencies such as Optimism (OP), Matic, SNX, OMG, LRC, RDN and INJ are likely to rally in 2023. Their values may rise sharply due to the demand of the products they support.
Will 2023 be a crypto winter?
The crypto winter is likely to get into 2023 unless there are key changes in the global economic trend. One reason that will perpetuate the crypto winter into 2023 is the low confidence that exists in the market at the moment, following the collapse of FTX, LUNA and TerraUSD. Presently, there are several crypto projects such as BlockFi and Celsius that have filed for bankruptcy. This creates fear in the market and reduces market confidence.
Is 2023 a bearish year?
Based on the current global economic outlook the first half of 2023 is likely to be bearish while the second half may turn to be bullish. Currently, many economists predict a likelihood of a recession which can inflict further damage on the fledgling crypto market. The second half of 2023 may become bullish if the Fed halts interest rate hikes.
