Cryptocurrencies have had an extraordinary year. Bitcoin fell to record lows, stablecoins were lost forever, lenders and investment platforms collapsed into bankruptcy and lenders/platforms failed.
As with traditional stocks and bonds, cryptocurrency prices are unregulated, leaving investors exposed to scams and rug pulls – leading to both exhilarating bull runs and devastating crashes.
Factors That May Send Cryptocurrencies Crashing
Cryptocurrency investors who saw Bitcoin and other coins skyrocket over the past several years may now be facing an imminent collapse. According to data from CoinMarketCap, one coin’s price plummeted this week and caused ripple effects throughout the market.
This crash serves as a reminder that cryptocurrencies are speculative assets, not money assets, and their prices can fluctuate widely depending on a variety of factors such as regulatory developments, rumors or sentiment. They could even be affected by macroeconomic factors like interest rates.
Not surprising: Cryptocurrencies share many similarities with stocks; similar forces affect them both, such as rising interest rates causing investors to shift away from risky assets like cryptos and stocks toward safer investments such as cash and gold.
An unexpected shift in investor trust can result in a sudden crypto crash, like we witnessed this week. Therefore, it is crucial that you diversify your portfolio and do not place too much of your savings in cryptocurrency investments; sticking to your investment plan should help protect against major losses should another crypto crash take place. Keeping yourself up-to-date on developments surrounding cryptocurrencies and their markets may also prove invaluable.
Liquidity Issues
Liquidity refers to how easily an asset can be bought or sold without significantly impacting its price. Assets with high liquidity tend to attract more buyers; those with lower liquidity tend to attract fewer.
Cryptocurrencies can be highly volatile investments, and their volatility may become even greater if there is a liquidity crisis. When more sellers outnumber buyers, prices may fall rapidly.
Numerous major cryptocurrency exchanges suffer from low liquidity, making it more difficult for investors to buy and sell assets on them, leading to crashes and losses for investors. Furthermore, investing in cryptocurrency with limited liquidity isn’t recommended if you plan to hold them long term.
Decentralized finance platforms (DeFi) with limited liquidity may have difficulty paying back their users when needed; examples include Celsius Network’s suspension of withdrawals due to financial issues and Terra (LUNA) and its exchange FTX’s closure as examples of such platforms.
Staying informed about the state of the cryptocurrency market is the best way to protect yourself against its crash, helping you understand how your investments may perform during a collapse and prepare accordingly. Furthermore, consider keeping some cash reserves which could be used when the price dips dramatically to purchase cryptocurrency investments at discounted prices.
Systemic Issues
Systemic issues refer to problems that affect all parts of an established system at once. If all your dogs at doggy day care get fleas, that would be considered systemic for all. Cryptocurrencies also frequently experience this type of systemic issue where prices can drop as a result of systemic issues affecting multiple currencies simultaneously.
One of the key contributors to a cryptocurrency crash is when leveraged investors sell off large portions of their holdings quickly, and this event can have devastating repercussions due to low liquidity on cryptocurrency markets; no buyers are always waiting on hand ready to pick up unloaded coins. Weekends tend to witness sharper crashes because there are fewer investors investing and consequently larger ripple effects when an influential whale sells off some holdings at once.
Rising interest rates are another key factor that are impacting cryptocurrency prices negatively, making it harder for people to afford the cryptocurrency they wish to invest in and leading them to sell for a loss. All these factors play a part in driving prices down, making it vital that investors conduct thorough due diligence before purchasing any cryptocurrency assets.
Macroeconomic Issues
Crypto has grown so popular as to inspire Super Bowl ads and earn the attention of prominent financial firms (Fidelity Investments among them), yet is not considered a “risk asset” that would cause wide-scale economic declines. Still, prices may fall should the global economy worsen; when this occurs, risk assets tend to suffer too; therefore crypto market would likely experience price decreases as well.
Crypto markets face one major disadvantage due to limited liquidity, meaning when leveraged investors dump large portions of their holdings at once, prices can rapidly plummet. While similar effects occur on stock markets, when whales sell off coins the repercussions are compounded due to fewer investors being tuned in when this occurs on cryptocurrency markets.
Bitcoin and Ether may not experience liquidity issues as frequently, but other cryptocurrencies could still be affected. When stablecoins like TerraUSD or Luna lose their peg to the US dollar it can cause massive panic as many users look at these coins as a safe store of value – but once de-pegged many will rush to liquidate their holdings as quickly as possible – similar issues may also affect those pegged to more volatile currencies like Australian dollars.