Be Ready: What to Do When Crypto is Crashing

After reaching new highs in 2021, both bitcoin and ether, the coin powering the ethereum blockchain, have dropped in price in 2022. As of April 14, the price of bitcoin (BTC) dropped 3.12% in the past 24 hours and remains down by 13.92% on a year-to-date basis. Ether (ETH) has lost 2.59% in the past 24 hours and decreased by 18.44% since the beginning of the year.

Even though cryptocurrency prices are down in 2022, they aren’t at their lowest points in recent months. After reaching all-time highs last year, both bitcoin and ether saw sharp declines in July 2021. That may not offer a lot of comfort to investors who bought these coins earlier this year, however, as their cryptocurrency values depreciated year-to-date.

Is crypto crashing? It might be difficult to answer this question with certainty. Asset classes generally go through cycles that include crashes.

Here’s how to handle a crypto crash should one take place.

What could cause a crypto market crash?

A natural part of learning about investing money is being aware and prepared for the possibility of a crash, no matter what asset class you’re invested in. This includes cryptocurrencies. There are several reasons that may send crypto crashing.

Lack of liquidity

Liquidity is the ability to find buyers for all the sellers in a market. A market that has high liquidity is one where traders could easily redeem an asset for cash. A lack of liquidity in the crypto market may manifest in the form of a crash. Sellers may try to find buyers for their digital assets by dropping their asking prices, which could start a chain reaction.

In general, bitcoin and ether aren’t likely to run into liquidity issues because they have the two largest cryptocurrency market caps (the total value of their coins). They are also the two most frequently traded coins between crypto investors.

However, less popular cryptocurrencies might see price spikes followed by steep crashes. One example is when enthusiasts buy a less popular coin before attempting to find investors who would buy it. If met with a low level of interest, the price could drop as they desperately try to recoup some of what was paid.

Lagging cryptocurrency adoption

In some cases, the lag in cryptocurrency adoption could contribute to a crypto crash. The Pew Research Center found that only 16% of Americans have invested in, traded, or used cryptocurrencies.

Early adopters and crypto enthusiasts may feel the future of cryptocurrencies is bright. This could push crypto prices higher as expectations point to increasing adoption of cryptocurrencies as assets and even for everyday use.

However, if adoption between first-time users lags behind the level of enthusiasm, it could lead to price drops. Continued adoption might be essential to maintain the momentum seen in crypto prices over the past few years.

Sanctions or international bans on crypto

In September 2021, China declared all cryptocurrency transactions in the country illegal. This triggered a sell-off and led to downturns in cryptocurrency values.

Bans on cryptocurrencies slow down their adoption and could often lead to price crashes. Additionally, a large country like China has tremendous influence over worldwide adoption and use.

Other countries have banned cryptocurrency transactions, including Egypt, Bolivia, and Iraq. Additionally, some countries also offer de facto bans by introducing limitations through their central banks that affect how financial institutions might interact with cryptocurrency transactions.

Sanctions, on the other hand, may have a mixed effect on cryptocurrency prices. On February 24, Russian President Vladimir Putin ordered his military to invade Ukraine. In response, the U.S. and the European Union imposed a long list of political and financial sanctions against Russia.

The initial reaction was a spike in bitcoin and ether prices on expectations of higher Russian demand. But growing concerns about the war soon shifted the sentiment in the crypto market, sending bitcoin and ether values near their lowest point this year.

Shifting monetary policies in the US

Monetary policy in the U.S. could also influence crypto prices. The Federal Reserve raised interest rates in March 2022, and more rate hikes are expected as the Fed attempts to keep inflation under control.

In general, higher interest rates could put pressure on stock prices and high-risk assets as uncertainty looms. A recent International Monetary Fund analysis discovered that cryptocurrencies, especially bitcoin, are increasingly correlated to stocks. As sentiment in Wall Street shifts to a more cautious one, it’s not surprising to see declines in cryptocurrency prices.

Additionally, the Federal Reserve is exploring the idea of a digital U.S. dollar. This may be viewed as a big step forward in cryptocurrency adoption. But if reserve banks issue their own digital currencies on the blockchain, this could potentially cause a crypto market crash as unofficial currencies may become less necessary.

Influence from major cryptocurrencies

In some cases, if major cryptocurrencies such as bitcoin and ether decline, other cryptocurrencies might drop as well. Crypto investing on a platform such as Coinbase or Binance.US allows you to see which cryptocurrencies might be correlated.

For example, both cardano and dogecoin often move with bitcoin and solana tightly follows ethereum. If the price of one of these major cryptocurrencies crashes, it’s likely to bring other crypto assets down with it.

5 things you could do before a crypto crash

If you’re concerned about potential crypto market crashes, there are some steps you could take ahead of time to protect yourself. Dealing with potential asset crashes is an inherent part of investing.

That’s why being prepared ahead of time makes a lot of sense, whether you’re just learning how to buy cryptocurrencies or you already own crypto assets. Here are some ideas to better prepare your portfolio for a crash.

1. Diversify

A diversified portfolio is essential when making sure you aren’t relying too much on one asset or asset class. Include a variety of assets in your portfolio by making sure you have exposure to stocks, bonds, cryptocurrencies, and commodities. Depending on your portfolio goals and risk tolerance, you could also add other assets such as real estate or non-fungible tokens to your portfolio.

In addition to diversifying across several asset classes, you could also diversify your cryptocurrency holdings. Consider adding a variety of coins by looking for cryptocurrencies with good potential. This would give you more options in the event of a crypto crash.

Read our comparison of cryptocurrencies to explore some of your options.

2. Invest in more established cryptocurrencies

Cryptocurrencies that are well-established could be more resilient and might recover faster from a crash. Just as blue-chip stocks are likely to recover faster from a stock market crash, established cryptocurrencies such as bitcoin, ethereum, and litecoin are more likely to see a faster recovery following a crash.

On the other hand, meme coins and more speculative cryptocurrencies might have a harder time recovering from such an event. Make sure to include some of the “blue chips” cryptocurrencies in your portfolio by learning how to buy and sell ethereum, bitcoin, and litecoin.

3. Be informed of recent trends

Pay attention to what’s happening in the crypto market. When you know what’s going on, you could be better prepared for a potential crypto market crash. You have time to position your holdings and get ready for what could happen.

It may not be possible to pinpoint exactly when a crash will happen (or when a recovery will occur). Being informed of the recent trends gives you a general idea of the market direction and allows you to make adjustments if needed.

4. Keep liquid savings

Make sure you have some liquid cash in an amount that you’re comfortable with. This could help you ride out potential crashes. When you have savings available, you don’t have to sell your assets at low prices.

Additionally, with liquid savings, it’s possible to buy more of an asset while it’s at a low point. If you think cryptocurrencies have long-term staying power, it could make sense to buy more of them during a crash so you could make more profit as they recover.

5. Use a crypto exchange with low fees and simple trades

When buying and selling cryptocurrencies, look for an exchange with lower fees. With lower fees, you could perform your trades while keeping more of your money for yourself. Higher fees eat into your real returns, and this could lead to less effective trading.

Additionally, make sure to use crypto exchanges with simple trading interfaces. This could allow you to act quickly when you need to. Learn how to cash out bitcoin and other cryptocurrencies on the exchange you use ahead of time.

5 things you could do after a crypto crash

If the crypto market is crashing, it’s essential to be aware of what to do next. More often than not, the best thing to do is nothing — unless you want to buy more of a cryptocurrency while it’s “on sale.” Here are some actions to consider when the crypto market is crashing.

1. Remain calm

In any situation where a market is crashing, it’s important to remain calm. We rarely make good decisions when we panic. Take a deep breath, stay calm, and don’t do anything on a whim. Before deciding to sell, carefully consider why you have that impulse. If it’s a worry because the market is dropping, you might be better off waiting.

2. Learn about dealing with market volatility

Learning to face market volatility could be difficult at first. However, it’s important to become resilient to volatility because cryptocurrencies can be very volatile at times and have frequent price swings. It’s likely your crypto portfolio has seen or may see some strong price movements. Preparing mentally for such movements may enable you to ride out a potential crash.

3. Use a buy-and-hold strategy

With a buy-and-hold strategy, you look for assets you think will perform well in the long term and you keep them regardless of shorter-term trends. A famous strategy in the crypto market is known as HODL, an acronym for “hold on for dear life.” This strategy, which began as a mere typo, came to refer to the idea of buying and holding a crypto asset.

If you think cryptocurrencies are the future, consider looking for coins you believe in. You’d then hold them through anything, including a crash, as you believe they will eventually recover.

4. Stay diversified

Diversifying is as important after a crash as it is before one. Following a crypto market crash, make sure to review your portfolio to stay diversified. A crash is not the time to consolidate and reduce your portfolio’s diversity.

If you have a planned asset allocation, stick to it, even after a market crash. When you stick to your plan, you’re more likely to succeed in the long run.

5. Focus on the long term

Short-term price fluctuations are common in the cryptocurrency market. Historically, many cryptocurrencies, especially ethereum and bitcoin, have seen an upward trend. If you truly believe cryptocurrencies are the future and that blockchain technology will continue to grow, look forward to that and don’t be swayed by short-term crashes.

FAQs

Bottom line

Crashes happen in all markets, and it’s difficult to know when they will happen. This is especially true with a new asset class like cryptocurrencies. Because cycles of crashes and recoveries are a natural part of investing, it’s important to set realistic expectations, know what smart moves you could take during a crash, and create a portfolio strategy you can stick to.

Disclosure: The author owns cryptocurrencies mentioned in this article, including bitcoin, ethereum, solana, litecoin, and dogecoin.