With over US$300 billion in value lost, here’s a look at the reasons behind crypto crashes and how investors can better prepare for such events.
With more and more people holding cryptocurrencies today, the crypto crash of May 2022 has had severe financial consequences. Reliable currencies, including Bitcoin and Ether, met a terrible fate, as did stablecoins, amounting to losses of over US$300 billion. Of this amount, stablecoins TerraUSD (UST) and Terra (LUNA) were responsible for a loss of over US$270 billion.
UST and LUNA are tied together using algorithms that ensure stability. To mint UST, you have to burn the dollar-equivalent amount in LUNA. In March 2022, they also included Bitcoin in the mix to boost stability further. However, as the stock market collapsed in the first couple of weeks of May 2022, Bitcoin also collapsed and, by consequence, Terra as well. The cryptocurrency, the third-largest stablecoin by market capitalization, was down 100%, with its value falling from US$119 in April to very close to zero today. Calling this a devastating downfall would be an understatement.
So, why do cryptocurrencies crash?
Before you resort to cursing your fate (“why me?!”) and dubbing crypto—and everything related to it—a scam, consider the reasons behind the crash. For instance, a key reason behind the recent crypto crash has been rising interest rates. As rates rise, investors tend to move away from risky assets, like cryptocurrencies, and into less volatile investments, such as bonds. Along with that, the economic uncertainty brought on by the Russia-Ukraine war and Sri Lanka crisis are also contributing to the general stock market decline.
Cryptocurrencies, generally, are no strangers to such extreme highs and lows. For instance, in December 2017, Bitcoin hit a high price point of almost US$20,000, only to fall to around US$3,000 one year later. Ethereum isn’t immune to such market volatility either—in January 2018, it was trading at close to US$1,400 but fell to below US$100 just six months later. So, if you’re feeling disheartened by the recent crypto crash, take solace in the fact that you’re not alone—crypto investors have been here before and will likely experience such market volatility again in the future.
Five ways to prepare for a crypto crash:
- Don’t be motivated by FOMO
When it comes to crypto, the FOMO (fear of missing out) is real. Author and CEO of e-learning providers InvestDiva.com Kiana Danial asserts, “Any asset has ups and downs—cryptocurrency has more ups and downs because of the amount of hype and FOMO involved.” So, don’t just invest because a crypto is trending, prioritize your goals and research.
- Only invest what you are okay with losing
A rule of thumb when it comes to crypto-investing is that you should only invest as much as you’re okay with losing. So, set aside a certain amount that you feel comfortable with, and don’t go overboard. Given that crypto is extremely volatile, don’t take chances with loans or borrowing money. You might be unable to repay them. If you lose money, your goal should be disappointment, not devastation.
- Read the whitepaper and use-cases
When picking cryptocurrencies to invest in, don’t just judge on the basis of their popularity. For instance, lately, meme coins—that rose in value due to their fame—have been declining in value as investors move away from assets that offer no utility. So, to make sure you’re making worthy investments, read the crypto projects’ whitepaper thoroughly and see their use-cases. If they have limited or no use-cases, odds are that they will decline in value in the future.
- Diversify your portfolio
Ultimately, crypto projects are just experiments, as per the founder of web 3 education platform Bitinning, Kashif Raza. So, people should choose their experiments carefully. Instead of putting all your eggs in one basket, diversify! For instance, you could pick a reliable crypto, such as Bitcoin; a stablecoin whose value is pegged to the U.S. dollar; and a crypto project you are interested in and have done your research on. Your final investment portfolio depends on your risk appetite.
- See the bigger picture
Don’t think short-term. If a crypto is doing well, it’s not necessary that it would continue to do so in the future (as the recent crypto crash made evident). So, study trends and invest in projects that have long-term potential.
What to do when crypto crashes?
There are many strategies you can use once subjected to a crypto crash. For instance:
- According to the Founder and CEO of NFT marketplace Yunometa, Arijit Mukherjee, investors should just focus on HODL-ing (holding on for dear life) their crypto right now. As for new investors, he suggests waiting for the bottom to edge closer so as to avoid extreme losses. You can do so by following the latest stock market news and keeping an eye out for any positive signals.
- Don’t let your emotions get the best of you. Crypto-related suicides are a real problem, and it can be avoided if you don’t get too emotionally attached when investing. Factor in your risk appetite and an indispensable trait of cryptocurrencies: they are unpredictable.
Finally, Raza asserts that investors should never forget that cryptocurrencies can completely lose their value. Pointing to the Luna fiasco, he reminds us, “Crypto can actually go to zeroes.” Largely, crypto lacks government regulation, and only some currencies are backed by traditional assets and cash. Given that, there is no telling when the crypto market will crash and take all your money with it. So, it’s best to prepare for worst case scenarios and use strategies that won’t affect you too drastically in times like these.
Also read:
- How to Minimize Risks When Investing in Crypto
- Battling the Crypto Winter: How Investors Can Handle a Crash
- How Safe Is DeFi and Should You Invest in It?
- What Is Regulatory Clarity For Cryprto and How Can We Achieve It?
Header Image by Flickr
