What to do during a cryptocurrency crash

As one of the most volatile investment options, cryptocurrencies have been known to crash more than a few times throughout recent history. When this happens, the market value of coins and tokens can fall quickly and significantly, leaving investors anxious about what to do with their assets — and the potential losses they could incur.

What should you do during a cryptocurrency crash? In this AAG Academy guide, we’ll explain what a crash is, what can cause one, and how crashes can be identified. We’ll also look at whether cryptos are prone to crashing more frequently than other assets, and offer some tips on how you can deal with the fallout when a crash does occur.

What is a crypto crash?

A cryptocurrency crash is a sudden and significant decline in cryptocurrency values. Crashes are often unexpected, but they tend to be a side effect of another substantial event, such as an economic crisis or the collapse of a major project. When a crash occurs, many investors quickly sell off their assets in an effort to recover as much capital as they can before things get worse.

The word “crash” is certainly a sensational one, evoking images of destruction and havoc. But in actual fact, it’s not always as dramatic as that. The widely agreed definition of a crash in traditional financial markets is a price drop of over 10% during the course of a single day. It’s rare that stock prices move that much in just 24 hours, but it’s not so rare for cryptocurrencies.

Cryptocurrency investors usually become concerned when major assets begin to suffer high selling volumes, and prices start to drop below the 50-day or 200-day moving averages. This signals that what we are witnessing is more serious than just a common correction and more likely a widespread decline in market values, and it typically gets worse before it gets better.

One of the most significant crypto crashes in recent history occurred in May 2022, when Terra — which was supposed to be a stablecoin — imploded. Terra was pegged to its sister token, Luna, which saw its value fall from a high of over $120 a coin to effectively zero, wiping out over $50 billion in market capitalization, after investors lost confidence in the project.

This caused what many refer to as a “death spiral,” which ultimately led to the collapse of both Terra and Luna. A major event like this results in a snowball effect, so other cryptocurrencies tend to suffer, too. Bitcoin’s value fell by more than half from its peak in November 2021, while the cryptocurrency industry as a whole incurred losses of over $400 billion.

Why do crypto markets crash?

There are many things that can potentially lead to a cryptocurrency crash. One of them, as we touched on in the example above, could be the collapse of a major project or exchange. This can cause some traders and investors to lose confidence in the cryptocurrency industry as a whole and try to offload their digital assets as quickly as possible in fear of wider declines.

The implosion of FTX in late 2022 is another recent example of this. After a surge of customer withdrawals, former FTX CEO Sam Bankman-Fried was forced to admit that the company did not have enough assets in reserve to meet customer demand, and so FTX filed for bankruptcy. This led to a substantial increase in withdrawals from other big exchanges, such as Crypto.com.

External factors, like higher interest rates, inflation, and other macroeconomic events, as well as things like the threat of cryptocurrency regulation, can also lead to investors becoming more concerned about where they put their capital. When this happens, they tend to favor traditionally safer investment options, such as stocks and bonds.

Do crypto markets crash more frequently than traditional markets?

It’s important to note that cryptocurrency is inherently more volatile than other assets. This is due to a number of reasons — like the lack of regulation and the fact that cryptocurrencies are entirely digital — and it means that prices fluctuate more widely and more frequently than those of other assets. See our in-depth guide to volatility to find out more on this.

Because of its high volatility, cryptocurrency has always been considered a risky investment. While it may give traders the opportunity to generate large profits in a short space of time, it can just as likely lead to large losses. Luna is proof of that; it hit an all-time high of $116.42 per coin in early April 2022, then crashed to $0.0001147 per coin just over a month later.

This makes most investors, particularly those who are in a position to make big investments, incredibly wary about quickly losing significant capital. It is not uncommon to see large selloffs when cryptocurrency markets are down, and once that begins, other investors tend to follow suit, which only makes the decline more serious.

Another important factor that leads to more frequent crashes in the cryptocurrency industry is the fact that almost all cryptocurrencies lack independent value. Unlike a public company, for example, they do not generate cash, so their value is solely determined by investors’ willingness to put money into them rather than how much money they could make in the future.

Furthermore, traditional financial exchanges have what are known as circuit breakers, which pause trading automatically when prices fall too quickly. Cryptocurrency exchanges do not have these, so their values are free to fall as quickly and as substantially as they please.

How can you spot a crypto crash?

It can be near impossible to predict a cryptocurrency crash before it actually happens, as we touched on above. Although there are certain factors that have traditionally caused a drop in crypto values, such as the threat of regulation and others we’ve already outlined, there are others that can have totally unexpected consequences on crypto markets.

As a result, we cannot be certain that one event, like an increase in interest rates in one country, will have any effect on cryptocurrency prices at all. This makes it incredibly difficult to forecast crashes and declines in advance. However, according to some cryptocurrency experts, there are three primary ways to spot a crash as early as possible. Those are:

Technical analysis
Technical analysis is the study of cryptocurrency price charts, which is a common technique traders use to predict how the value of an asset might change over time. Keeping a close eye on these, and looking out for bearish patterns and high volatility in particular, can help us spot major declines early on.

On-chain analysis
On-chain analysis, which involves analyzing blockchain data, including cryptocurrency transactions and wallet balances, is another technique traders and investors use to evaluate investment opportunities. This can help investors identify the “generational bottom” (the lowest price in each cycle) for a coin or token, and how current prices compare.

Macro conditions
Macroeconomic conditions include things like inflation, growth, interest and foreign exchange rates, and more. Although many believe that cryptocurrencies are an ideal hedge against traditional investment options, the reality is that many of them are actually closely correlated to equities. In other words, when things like stocks are up or down, cryptos tend to follow.

With that being the case, being aware of those things — and how other markets are reacting to them — can help us predict how crypto markets may react to external factors.

Again, it must be emphasized that it is near impossible to predict a cryptocurrency crash before it happens. However, with the right research, there is a chance we can spot them early, which is useful if you’re the kind of investor who tends to avoid these things by selling off the assets you hold as quickly as possible.

Are certain cryptocurrencies more likely to crash?

All cryptocurrencies are volatile, so when a crash occurs, almost all of them tend to be impacted to some extent. How significant that impact is can depend on the cryptocurrency itself. For instance, smaller projects that aren’t well-established — and aren’t very valuable — are likely to feel the impact a lot harder than the likes of Bitcoin and Ethereum, as you might expect.

Part of the reason for this is that investors typically have a lot less confidence in newer projects. While many will hold onto their BTC during a crash with the belief that its value will rise again, it is usually a lot more difficult for startup projects to bounce back after a major slump, so many investors will try to offload those assets at the first sign of a major decline in token price.

That doesn’t mean, however, that larger cryptocurrency projects are immune to crashing or that they will always recover from a crash. Certain situations, like the threat of regulation or simply a sudden lack of trust in a project, for example, can have a bigger impact on larger cryptocurrencies, and the Luna collapse that we covered earlier is proof of that.

What can you do to avoid a crypto crash?

The only way you can truly avoid cryptocurrency crashes is to not invest in cryptocurrency. Other than that, there is no surefire method for total immunity to them. However, as we mentioned above, there are things you can do — such as conducting the right due diligence and keeping yourself up to date on market trends and events — to minimize their impact.

In certain situations, the best way to minimize the impact of a crash might be to sell your assets as quickly as possible. In other situations, however, it may be a much better idea to hold onto them until prices bounce back to pre-crash levels — or even higher. Only you can decide which move is best for you based on your own investment strategy and your situation at the time.

It’s also a good idea, regardless of whether or not a crash might be imminent, to follow best practices when it comes to investing. One of the most important rules of thumb is to never invest more than you can afford to lose — or to put too much of your capital into a single or similar group of assets. This can greatly reduce the financial impact that losses can have.

During a crash, it’s best to remain calm and not make rash decisions. While selling may be the right option for you at the time, it is important to remember you may still suffer large losses, and you don’t want to regret your decision later when markets return to normal. Try to focus on the long-term and what’s best for your strategy as a whole.

References

• Crypto crash vs correction what’s the difference
• What happened to terra
• Why are cryptocurrencies crashing
• 3 signals a crypto crash may be coming according to experts