Cryptocurrency is often lauded by its enthusiastic followers as the alternative safe haven, the digital gold, the inflation hedge for the masses. Well if that’s so why is it crashing? This article will take a look at the reasons.
Crypto is so volatile that the lure of quick and easy gains is often too easy to resist. Wrapped up in the technological mystique of a digital asset that can be traded easily worldwide without middlemen and restrictions, it’s easy to think crypto is infallible. The allure of crypto, a kind of digital ‘Robinhood’ is that it allows the masses; the ‘little’ man and woman to participate in activities that were once only the purvey of the rich. This fundamental nature of crypto is the first reason why crypto crashes.
Short-term investors
Whenever a large group of people pile into an asset, one thing usually happens; the price goes up. When more short-term investors see the price rising, they too pile in pushing the price up more. When the price reaches its peak, early short term investors sell for quick gains, causing the price to plummet. Those that entered late in the game are left holding their expensively purchased asset hoping for another day when the asset will go to the moon. Unlike traditional stocks and shares, crypto by its very nature attracts investors that are looking for quick returns. They are often the first to bail out at the first sniff of a profit. This short-term investor mindset will often cause crypto to crash.
Fear and Greed
Yes, fear and greed are emotions we can all relate to. The intense desire to want something, the craving for wealth at all cost is often insatiable. However, this is not a simple moral debate. Financial indexes such as the Fear and Greed index highlight effectively how human emotions can cause high volatility in markets. Cryptocurrency is not immune from such market sentiment. Humans are amazingly predictable when acting en-masse. When the crowd is fearful, the majority will sell causing the price to fall. When they are greedy they will buy, causing the price to rise. If you combine a short-term investment mindset with a fearful or greedy investor you create a highly combustible mix.
Larger Market Conditions
Cryptocurrency traders will often create fancy technical analysis charts hoping to predict the future performance of an asset. In reality, such charts may be able to reveal certain cycles in the asset in question but often they are limited in their view of macro conditions that can cause dramatic price movement of digital assets. Larger market events that can cause crypto to crash include excessive regulation, rise in interest rates, recessions and wars to name but a few. Combine a few of the above and you can be almost certain your crypto will crash, no matter what your technical analysis chart says.
The Economic Cycle
We have extremely short memories. Every new generation thinks that they are the ones who will change the world and make it a better place. Unfortunately, history has an uncanny ability to repeat itself. The economic cycle can be thought of as the rising and falling of a market economy. What this means in simple terms is that periods of expansion, peak, contraction and trough can be roughly predicted. In 1997, the Tech Bubble burst. In 2008, the Subprime mortgage crisis or Credit Crunch. In 2020, we had the Covid-19 lockdown recession. The pattern is clear, every ten years or so, the world economy is likely to collapse, no matter how well it was doing previously. If you are holding crypto through such a contraction period, your crypto is likely to crash too.
Manipulation
In every market, there are ‘bad actors’. People who wish to game the system and make maximum profit on the backs of others. Crypto is no different from traditional markets in that large holders of assets can purposely cause the rise and fall of assets by selling and buying at specific moments in time. The difference with crypto is that it lacks regulation to prevent excessive market manipulation. This means that rogue projects can be set up overnight, bolstered by huge marketing or a celebrity front person, pumping the price of the said asset to the moon only for the founders to sell it all at the peak. This inevitably causes the price to crash; the classic ‘Rug pull’.
Final Thoughts
So, in theory, crypto is a tool that has the potential to be the digital currency of the future. Decentralised and unmanipulated by governments or individuals. But the unfortunate reality is that human nature has too much of a bearing on the crypto market. Without somehow detaching itself from the peaks and troughs of our deep-rooted fear and greed, it will continue to be extremely volatile. With that comes great opportunities and also great danger. Tread carefully.
This is not financial advice.
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