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Lesson 5: Cryptocurrency Crash

Lesson 5: Cryptocurrency Crash

Cryptocurrency may experience falling prices as it is prone to volatility. Here is how to recognize and handle a cryptocurrency crash.

The end of 2021 hasn’t been the cryptocurrency revolution that everyone was expecting it to be. In fact, analyzing the Crypto price charts, it’s easy to see that most cryptocurrencies have dropped significantly since mid-November 2021.

The cryptocurrency market is getting more interest from investors, especially millennials. A Pew Research Center survey estimates that 16% of Americans have invested in or at least used crypto.

Bitcoin, the largest cryptocurrency, reached an all-time high in November 2021, peaking at around $69,000. Back then, Ethereum, the second-largest cryptocurrency, also reached a new all-time high at around $4,890. As most cryptocurrencies follow the trend of the most two popular coins, the entire market was through the roof. However, the bull market came to an end sooner than expected, and most cryptos plummeted by more than 50%.

January 2022 saw major selloffs, as Bitcoin dropped to around $34,000 and Ethereum followed it, plunging more than 50%, reaching around $2,200.

Cryptocurrency crash
Bitcoin Weekly Chart (Source: CAPEX Webtrader)

According to CoinMarketCap, the sell-off has intensified a two-month-long slide in the global cryptocurrency markets that have vaporized $1.4 trillion. After hitting a peak of about $3 trillion in November, the total digital asset value was just above $1.6 trillion in January 2021.

Vocal supporters of Bitcoin and other cryptocurrencies suggest that they can transform finance. These are the true holders. They are pushing crypto to move further into mainstream usage as a store-of-value or payment option. However, many people buy and sell crypto to make a quick profit, even as the cryptocurrency prices are falling.

How to use this guide

  • Learn how to manage your investment when crypto prices are falling
  • Open a trading account to get access to our platform
  • Ride cryptocurrency falling and rising prices with CFDs

Why cryptocurrency falls

As new investors try to make sense of the cryptocurrency market, there is one question that keeps on coming back, which is “Why are cryptocurrency prices falling?”.

There is no definite answer to that question, but we can point out some of the factors that have influenced the market before.

The first thing that may influence a big market sell-off is the new perspective that investors have over their crypto portfolios. When massive market shifts take place, it’s probably because many investors decided to change their portfolios at once. In this case, they might be removing risky investments from their portfolios. While reassessing risk tolerance is an explanation, this may only be part of the answer.

Other elements that may contribute to the cryptocurrency falling are the high inflation and the newly imposed regulations to support the economy. As more countries are starting to decrease contaminant pandemic safety measures, the economy is starting to recover. Even though Bitcoin and most cryptocurrencies have lost around 50% in value after the November 2021 spike, BTC could reach $100,000 in the future, according to Goldman Sachs Group.

The U.S. Federal Reserve evaluates the potential of a central bank digital currency (CBDC), and it launched the Money and Payments: The U.S. Dollar in the Age of Digital Transformation report. While they cannot provide any precise answer about the future of digital currency, they are providing the pros and cons of a digital coin and are open to public discussions.

The network blackout in Kazakhstan is another reason for the decline in cryptocurrency prices. Kazakhstan is one of the top locations with a rapidly growing cryptocurrency mining industry, so the internet shutdown in Kazakhstan affects the value of digital coins. It accounts for about 18% of the world’s cryptocurrency miners, as most moved from China after the 2021 crypto mining ban.

How to manage your existing investments if the crypto market crashes

The volatility of the market attracted many new investors in 2021. As a new investor, the bear market that started at the end of 2021 could feel especially harsh if it’s the first crypto market crash you experience.

Nonetheless, setting a clear trading strategy could help get through a cryptocurrency market crash. Here are some tips to get you through these rough times, as cryptocurrency prices fall.

Keep calm

You’ll need to keep your calm as you see cryptocurrency markets moving faster than you can identify opportunities. Oftentimes, these sudden price movements cause emotional decisions, which are the worse kind of decisions for traders. That’s why keeping your calm to assess the situation is important.

During this time, it might be a promising idea to re-analyze your portfolio and reiterate the reasons behind your investments. Most cryptocurrency investors find themselves on one of the two sides – they want to make a quick buck or believe in the long-term opportunity. Understanding your reasons for trading crypto might guide you to act according to your financial expectations and goals.

Buy and hold

The first piece of advice you’ll hear when you start investing in cryptocurrency is buying low and selling high.

But you’ll soon find out that you can’t predict the market. That’s why some investors take the long-term approach, where they do not have to worry about the short-term price changes.

It’s still important to buy into a project you think has true potential to perform well over the next five to 10 years.

At the same time, cryptocurrency dips can also be an opportunity to invest more into your favorite cryptocurrency project. If you were waiting for the right time to buy a token, which you believe has a strong long-term potential, then this could be a suitable time. However, you may be tempted to buy other tokens too. Remember that it’s never a good idea to buy crypto that you have not thoroughly researched just because it’s on sale. Also, you should only use your disposable income to buy cryptocurrency.

Learn to hedge crypto risk

Investors concerned about their exposure to crypto risks should reduce the size of their crypto holdings or even close those crypto positions. However, hedging can be a good strategy for traders who want to preserve their crypto holdings, while having a neutral exposure.

Cryptocurrency investors can hedge their portfolios by placing orders in the futures market or spot market through CFDs (contracts for difference). You can do so on trading platforms or trading apps that provide access to a wide financial market, including cryptocurrency, commodities, forex, bonds, shares, and more. CFDs are flexible derivates, as they do not have an expiration date.

With CAPEX, CFDs can be traded on spot and futures prices for the most popular cryptocurrencies. CFD futures trading is similar to futures trading in the underlying market. However, you can trade on price rises or falls without having to accept any obligations associated with futures contracts.

Let's say you own 1 Bitcoin. You believe the technology behind Bitcoin has long-term potential. At the same time, you fear that the volatility of the short-term could affect your position. You decide to temporarily hedge your Bitcoin instead of selling it. You open a CFD trade to short Bitcoin. You can close your CFD trade once there is no negative price movement. The profit from the CFD trade will offset any loss to your cryptocurrency holdings. If Bitcoin's price doesn't fall, the profit from your holding would compensate for any loss to your Bitcoin-related CFD.

How to start hedging cryptocurrencies

  • Conduct research. Learn about financial markets with CAPEX Academy’s range of online courses
  • Learn how to trade. Discover how to trade cryptocurrencies
  • Practice your crypto hedging strategy. Trade-in a risk-free environment using a CAPEX demo account
  • Start hedging Bitcoin and other cryptos. You can open a live trading account in minutes with our simple online form

How you could profit from cryptocurrency falling prices

If you have made the first step to understand your reasons behind your crypto investments, you can now more easily ride cryptocurrency falling and rising prices. Luckily, it is possible for investors to profit from the crypto falling prices by using one of these cryptocurrency investment strategies:

Shorting cryptocurrency with CFDs

Traders have diverse investment tools to try to profit from falling cryptocurrency prices, such as derivatives. If traders expect that the price of a cryptocurrency will fall soon, they can “go short” on that asset.

The profit comes from the difference between the opening price and the closing price of the position multiplied by its size. However, if the market will move in the opposite direction as open position losses may occur as well.

Trading cryptocurrency derivatives means that instead of owning bitcoin outright, you’ll be speculating on its price with CFDs. As a result, you’ll be able to take a position on bitcoin’s price rising by ‘going long’ or falling by ‘going short’.

CFD Trading Example for shorting Bitcoin

Let’s say you want to short Bitcoin because you believe its price will fall soon.

Cryptocurrency falling
Bitcoin Spot Daily Chart (Source: CAPEX Webtrader)

Bitcoin is trading at a bid price of 35,219.15. You want to sell 0.1 CFD (units) because you believe that the price of BTC will go down. Bitcoin has a 1:2 leverage or a margin rate of 50%. This means that you only need to deposit 50% of the position’s value as a position margin.

Your CFD position margin will be $1.760.96 (50% x (0.10 units x $35,219.15). However, if the price moves against you, it is possible to lose more than your initial position margin of $11.760.96.

Outcome A: a profitable trade

Your prediction was correct, and the price falls over the next 2 days to a bid/ask price of $27,400.65/27,519.15. You decide to close your trade by buying back at $27,519.15 (the new buy price).

The price has moved by $7,700 (35,219.15 - 27,519.15) in your favor. Multiply this by the size of your position (0.1 unit) to calculate your profit, which is $770 gross.

Let us assume the position was closed after 2 days, the overnight swap calculation formula will be:

  • Overnight swap = 0.10 (units) x $31,658.40 (average price at rollover) x 0.0549 % x 2 (days) = $3.47

Therefore, your total profit on Bitcoin CFD is your gross profit minus the rollover cost.

  • $770 - $3.47 = $766.53 net profit

Outcome B: a losing trade

Unfortunately, your prediction was wrong, and the price of Bitcoin rises over the next hour to a sell/buy price of $42,918.50/42,919.15. You feel the price is likely to continue up, so to limit your potential loss, you decide to buy at $38,490.15 (the new buy price) to close the position.

The price has moved by $7,700 (42,919.15 - 35,219.15) against you. Multiply this by the size of your position (0.10 units) to calculate your loss, which is $770.

If you are not ready to trade CFDs at spot or futures prices yet, we have also got educational resources like CAPEX Academy with free courses on how to trade. Plus, we offer a demo account – giving you $50,000 in virtual funds to build your confidence in a risk-free environment.

Shorting crypto and blockchain linked funds

A cryptocurrency exchange-traded fund (ETF) is a fund consisting of cryptocurrencies. While most ETFs track an index or a basket of stocks, a cryptocurrency ETF tracks the price of one or more digital currencies. Crypto ETFs are far less volatile than single digital asset investments and offer investors exposure to digital assets without needing a crypto exchange.

The first-ever Bitcoin ETF was launched in October 2021. The ProShares Bitcoin Strategy ETF (BITO) Tracks Bitcoin futures contracts, and it is tied to the price of the cryptocurrency.

Cryptocurrency crash
Bitcoin Spot Daily Chart (Source: CAPEX Webtrader)

Blockchain ETFs are trading stocks of companies that use blockchain technology. This is referring to any public company that may use blockchain to develop its product and services, which is increasingly applicable in multiple industries, such as banking, retail tracking, logistic chains, and many others.

The largest blockchain ETFs in terms of total assets are Amplify Transformational Data Sharing ETFs (BLOK), Siren ETF Trust Siren Nasdaq NexGen Economy ETFs (BLCN), First Trust Indxx Innovative Transaction & Process ETFs (LEGR), Bitwise Crypto Industry Innovators ETFs (BITQ), and Global X Blockchain ETFs (BKCH).

Like you would short stocks, you can short ETFs if you expect the price of Bitcoin and other cryptocurrencies to fall. Going short is the reverse of going long, enabling you to profit if you correctly predict a depreciation in a fund’s share price.

However, please note that shorting is a high-risk trading method because prices can keep rising – theoretically, without limit. It’s essential to take steps to manage your risk.

Once you’ve set up a live trading account with us, you’ll have over 50 CFDs on ETFs from which to choose.

Buy at the bottom

While the cryptocurrency market is the most volatile investment market there is, it means that it can go both directions. Many new traders got excited in 2021 after they saw most prices going up without much correction.

However, now as they saw a huge cryptocurrency plunge, many took their money out of crypto. But that’s not to say that the prices of cryptocurrency couldn’t go up again. The truth is that nobody can predict what will happen. But researching projects and their communities may help you distinguish between those worthies of new investors and the less promising projects.

If you believe that a project stands a good chance of innovating and building something useful for an entire industry, buying at the bottom is a good strategy.

Remember to act with caution. Most crypto communities are urging new investors to “buy the dip”, but not all are well-intended.

As the cryptocurrency space remains highly unregulated, there is no telling who means well and who isn’t. Investors are always advised to invest only money they afford to lose and conduct due diligence.

How to recognize a crypto bear market

Markets can be described as either a bull or bear market, and these terms apply to stocks, real estate, cryptocurrency, or other assets. A bull market is one that is growing, while a bear is one that is declining.

Bear Markets refer to a time when supply exceeds demand, confidence is low, and cryptocurrency prices are falling. A crypto bear market is a situation in which major cryptocurrencies such as Bitcoin have lost at least 20% since their highs and are still falling. Pessimistic investors are called "bears". Bear markets can be challenging to trade-in, especially for novice traders, because cryptocurrency prices are falling. A crypto bull market, on the other hand, is one where the prices of major cryptocurrencies are rising.

The most well-known crypto crash was in December 2017. Bitcoin dropped from nearly $20,000 to less than $3,200 within days. But in April 2021, BTC rallied to almost $65,000. Again, this steep upward trend was followed by a sudden drop to below $32,000 in May 2021.

While every bear market is different, there are general guidelines that you may use to spot a bear market before it happens.

Failed rallies in a low-volume environment

A crypto bear market's first stage includes rallies that cannot be supported. For instance, the BTCUSD chart will show a series of lower lows. This is clear evidence that the market has weakened and has become vulnerable.

Signs of low volume indicate that major investors aren't willing to enter the market.

No bounce-back

Usually, crypto markets experience corrections quite often. However, if the market isn’t able to retrace quickly, it’s usually a bad sign.

Acceleration to the downside

The crypto market starts to decline between 5-10% per day. The cryptos only see small gains every now and then. While the rallies are slower, the downward movements are swift. The volume rises during declines, while it decreases during rallies. Bullish investors won't sell at this stage.

Institutions start selling

Individual crypto investors are selling, which also forces big investors and institutions to reduce their positions. A slight fear is starting to settle in. Many investors are stubborn and refuse to reduce their holdings. They have pledged to stay true to their convictions.

Bad News

Positive tweets and positive news are not as popular during a bull market. As cryptocurrency prices plummet, investors feel panic. The most determined bulls will hold onto their crypto positions while secretly grinding their teeth. Investors are encouraged to think long-term, and to remember that bear markets will eventually end.

Bulls go into hiding

Most crypto investors vanish during this stage, as the bear market is confirmed. All financial and social media networks are spreading the bad news. Volatility rises and double-digit drops are common. The market is currently down at least 30%.

Capitulation

The bulls give up at this point. Investors look at their crypto wallets and realize that their portfolios won't be coming back to them soon. So, they sell in a panic. Volume is three times higher than normal. The crypto market is ready to blow. There is an avalanche in selling, and many investors are now down at least 50%.

Margin calls are ignored by investors, which increases selling pressure as brokerages liquidate investor accounts. Many investors express their intention to never again invest in the crypto market. Within a matter of months, many years of gains have been lost. Diversification formulas can cause many supposedly safe cryptocurrencies to plummet.

Although no bear market follows this exact pattern, it is a common scenario. Although no one can tell when a crypto bear market starts or ends, it is possible to look for indicators and clues that will help you decide when to exit or go back in. Bear markets are just as predictable as bull markets.

How to trade in a bear market?

It is notoriously hard to predict when the bear markets will end and when the bottom price will be reached. Rebounding is often a slow, unpredictable process that can also be affected by external factors like economic growth, investor psychology, world news, or current events.

However, bear markets can also present opportunities. If your investment strategy is long-term, buying in a bear market could pay off when the cycle reverses. Investors who have shorter-term plans could also profit from temporary price spikes and corrections.

For more experienced investors, going short is a strategy that bets on the possibility of an asset's price falling. Another strategy that crypto investors use is cost-averaging. This means you would invest a fixed amount (say $50) each week or month regardless of whether the asset is increasing or decreasing in price. This spreads your risk and allows for you to invest during bull and bear markets.

These trading strategies should be used only by experienced traders. That's because this kind of trade has the potential to bring huge gains, but it can also make a trader lose more than the initial investment. Traders are advised to use stop-loss orders, to reduce risks and losses they cannot afford.

Derivate trading instruments are extremely useful for traders looking to make a profit during a bear market. While buying and holding cryptocurrency is a good investment for cryptos that are expected to rise in price in the future, CFDs enable traders to speculate on both rising and falling markets. What’s more, when trading CFDs, you don’t need to deposit the whole amount to open a position. Traders are only required to deposit the specific margin for each crypto CFD. This also makes it easier to hedge your crypto trades.

  • Higher liquidity. Asset prices are sourced prices from multiple platforms, which helps us improve liquidity. As a result, trades are executed quickly and at lower costs.
  • Trade long or short. When purchasing cryptocurrency, it is an upfront purchase, and the trade can only be profitable if the value goes up. However, when trading CFDs, investors can also take advantage of falling cryptocurrency prices.
  • Leveraged exposure. CFD trading can be leveraged - you can open a position on a margin equal to only a fraction of the trade's full value. This means that you can gain a large exposure to cryptocurrency markets while only holding a small amount of capital. Leverage can increase profits, but it can also increase losses.
  • Faster account opening. You won’t need access to the exchange directly. You can quickly access the underlying market from your account. Setting up a new account is fast and easy, and you don’t need to create complicated crypto exchange accounts. This will allow you to get up and running much faster. In fact, you could be trading in less than five minutes, with our simple application form and instant online verification.

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