Since 2021, the crypto market has lost more than $2 trillion. Cryptos have been seeing significant losses, with the most recent plummet being witnessed by Bitcoin with a 9% decline. Already, crypto traders and experts are calling this a flash crash, but the reasons behind this crash remain a misery to most traders.
This, however, does not mean there are no theories circulating attempting to explain what has been driving the declines. The most recent Bitcoin decline in August is said to have been caused by traders liquidating crypto derivatives to prepare for the upcoming options expiration.
And even with the roller coaster of crypto, it is more and more being used in all industries especially online. Almost all online purchasing can be done with crypto, donations can be made with crypto, and even online casinos, like Ripper Casino are now accepting and paying out winnings with crypto.
That said, crypto crashes have been occurring and will probably continue to, and if you are curious why, here are the reasons:
1. Extravagant Levearge of the Investors’ End
Investors have been taking a considerable risk in the crypto market, resulting in high leverage ratios of cryptos such as Bitcoin.
You must be wondering why this is the case. Well, in traditional markets, investors use debt to purchase futures and hedge against future risks. Similarly, in the crypto market, traders are also using debt to finance futures purchases. However, this does not go without a ripple effect.
It often leads to volatility for cryptocurrencies.
Price drops witnessed on other asset classes often result in the liquidation of long-term positions. Unfortunately, the impact of crashes caused by too much leverage on the crypto market is worse than other markets since cryptos don’t have as much liquidity.
The August 17 crypto crash was triggered by a couple of factors, which include regulatory uncertainty.
Looking back at China’s move to ban crypto mining in 2021, we saw miners move to jurisdictions that allowed mining. Of course, this move saw a considerable wane in the network hash rate.
In case you are wondering about the implications of a decrease in the network hash rate, it exposes the network to heists and criminals and the possibility of attacks. More so, a low hash rate makes cryptos less decentralized, which translates as a risk for investors.
A low hash rate affects the rate at which miners produce coins and, consequently, the coin’s price. Essentially, when the hash rate declines, the prices also decline. When the government prevents crypto mining through regulations, crypto prices can decline.
3. Lack of Liquidity
The lack of liquidity witnessed in the crypto market is one of the causes of crypto crashes. This often takes place when investors in this space decide to liquidate a significant portion of their assets.
When you look at the stock market, you will find that there are usually many buyers looking to buy unloaded assets. The opposite happens in the crypto market. There is usually a small number of traders willing to buy coins when investors are liquidating them, which is also the reason why big institutions won’t trade small coins.
So, what happens when investors unload a big part of their assets in the crypto market? Due to the lack of liquidity, the crypto market ends up with a large supply of coins with a low demand.
4. Fear Caused by Security Breaches
Other factors that could contribute to a crypto meltdown include blockchain technology and network security. Similar to how regulatory interruptions caused by government actors would happen, this kind of crash would occur. For instance, if it appeared that Bitcoin had a security weakness, miners could be less inclined to work on it, which might lower the hash rate and lower the price overall.
The total number of Bitcoins that will ever exist is limited. Unlike stocks, which have underlying assets that support and stabilize them, the value of the majority of cryptocurrencies is solely determined by market emotion. Investors who want to own cryptocurrencies face the challenge of finding coins with a limited supply and a lasting appeal.
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5. Volatility Caused by Influencers
Crypto influencers are, to an extent, responsible for crypto crashes. With a simple tweet, crypto influencers and advocates can create a capital inflow. You have seen this happen in the past when Elon Musk supported Dogecoin.
The same tweets can also trigger capital outflows largely because cryptos lack liquidity and are often based on investor sentiments. The best way for investors to protect themselves from crashes triggered by influencer sentiments is to invest in stablecoins.
6. Stock Market Correlation
One of the factors that make cryptos appeal to traders is the fact that they are uncorrelated assets. While that is the case, it is important to note that some stock market and crypto market correlations exist.
For instance, there are those companies that are involved with the crypto space through business or investment. Through underlying price movements, their stocks correlate with the crypto market. Nevertheless, there is no consistent or concise correlation between the crypto markets and stock indices.
Crypto markets today continue to be interwoven with traditional markets thanks to traditional acceptance over the past couple of years. More so, some traders feel that there is a strong correlation.
The crypto market has been taking big dives in the past few years, with cryptos such as Bitcoin taking falls of as much as 45%. However, despite the volatility which is synonymous with the market, investors continue to show interest in cryptos.
As long as crypto adoption continues to increase, so will their stability. However, until cryptos become more stable, investors should be vigilant to avoid losses caused by crashes.