By Larry Wright
Introduction
Since the introduction of Bitcoin in 2012, the cryptocurrency has managed to increase many folds in value and showed potential for tremendous growth in the future. On one end, where cryptocurrencies are touted for generating faster and bigger profit margins in comparison to traditional investment options like stocks, bonds, and commodities, they are also subject to high market volatility. Therefore, bear markets are a fairly common phenomenon in the crypto sector.
What is a Bear Market?
The technical requirement for a bear market is that the price of an asset class is reduced by more than 20% and does not show any sign of recovery. For the cryptocurrency market, the official start of a bear market is alerted when the aggregate market cap of the cryptocurrency market has been reduced by 20% on account of the massive price devaluations and other economic factors.
According to projections by Binance Academy, there had been around 25 bear markets in US equity markets between 1929 and 2014. Since Bitcoin started trading and laid the foundation for crypto investing in 2012, there have been more than three major bear market periods in the crypto sector. As happens with all new technologies, the traditional investors and the rest of the world took their time to get used to the idea of blockchain technology and its advantages.
What Causes a Crypto Bear Market?
When it comes to understanding the causes behind bear markets, the answer is not always very straightforward. While it is possible to list down several underlying reasons that induce a bear market, it is impossible to predict the precise start or end of a bear market, even for professional investors and economists.
At any given time, millions of investors are making independent decisions to buy or sell different cryptocurrencies, and at the same time, factors like economic conditions, regulatory changes, investor confidence, and many others are shedding their impact on the cryptocurrency market.
Nevertheless, it is possible to develop a better understanding of digital investment by reading about a few basic influences behind bear markets:
- Macroeconomic Factors
- The decline in Trading Volume
- Sentiment Deterioration
- Backwardation
- Interest Hike
- Regulatory Intervention
Macroeconomic Factors
Economics and investment markets like the cryptocurrency sector are intertwined forces. The changes in macroeconomic factors are directly reflected in the form of negative or positive changes in the performance of cryptocurrencies.
Some of the most important macroeconomic factors are the rate of economic growth, unemployment ratio, inflation projections, interest rates, geopolitical, and exchange growth. It is worth noting that in comparison to Stock markets, the macroeconomic factors affected can vary in the cryptocurrency sector.
The Decline in Trading Volume
The peak of a cryptocurrency happens when maximum numbers of digital wallets that are holding that currency are actively participating in the trading activity. The measure of the total number of active digital currency wallets for a cryptocurrency is denoted by Trading Volume. When the Trading volume for a digital currency declines, it means that investors are experiencing a lesser interest in the token or coin on account of uncertainty.
Sentiment Deterioration
When the general sentiment in the market towards a particular cryptocurrency starts to move into the negative territory, it can experience a bear market. In 2017, Bitcoin prices were at their peak at $20K per unit. However, JP Morgan CEO Jamie Dimon issued a public statement calling the top coin a fraud that affected the opinion of many investors in the market. Shortly afterwards, the price of Bitcoin experienced a temporary crash.
Backwardation
Backwardation is a phenomenon when the price projections for the near term are smaller than the current market value of an asset class like cryptocurrencies. Backwardation occurs when technical analysts and crypto market data projections start to point towards an upcoming decline in price. Keeping in view the statistics, digital currency investors have started to liquidate their positions to make the most out of their investment.
Interest Hike
An interesting hike is the rate of interest that banks apply for lending or borrowing excess reserves. On account of the global pandemic, the Central Bank of several sovereign nations, such as the USA and China, has decided to spike the interest rates that have sent the investment sectors like stocks and cryptocurrencies into a bear market cycle.
Regulatory Intervention
The unfavourable changes in the regulatory requirements in a particular jurisdiction can create major changes in the cryptocurrency market. Last year, the Chinese government imposed a comprehensive embargo on the crypto sector that criminalized the act of crypto trading, advertising, mining, and promotion. The Chinese crypto exodus started an international bear market that lasted until the global hash rate of Bitcoin was restored eventually.
How to Identify a Crypto Bear Market?
When it comes to cryptocurrency trading, the profit of a digital currency investor depends on their ability to recognize the bear and bull market start effectively. It is important to understand that even the top economists and technical market analysts cannot predict the bear or bull market start accurately.
However, by learning about the main signs of the bear market, digital currency investors can read the early warning signs and make informed decisions. Here are some of the clear indicators of a bear market in crypto:
- Price decline
- Supply Shock
- Fear and Greed Index
- Media exposure
- Economist Negation
- Lower highs and lower lows
Price Decline
One of the most basic and visible signs of a bear market is the decline in the market value of a cryptocurrency. It is important to note that on the day to day basis, the price of a cryptocurrency can continue to increase or decrease.
However, until the price of a token or coin has been reduced by 20% the bear market is not declared official. At the same time, when the price of an invested cryptocurrency starts to go lower than 10%, investors start to look for other signs of an approaching bear market.
Supply Shock
The basic forces of supply and demand also impact cryptocurrency price action just like any other asset class. When the amount of a cryptocurrency increases too much in the crypto market, it means that its price is going to decline.
An increase in supply also points toward the fact that many investors are dissolving their positions and dumping the token under question, which means that the demand for the said cryptocurrency has started to dwindle.
Fear and Greed Index
The confidence among investors towards a given cryptocurrency plays an important role in maintaining its price value. Professional investors use the Fear and Greed Index to measure the sentiment of a cryptocurrency’s performance in the market. When the Fear and Greed Index enters the red zone, it means that investors have lost their confidence and trust in the stability and performance of the particular cryptocurrency, which means that it can lose its value.
Media Exposure
Cryptocurrencies are not physical currencies, and they are traded 100% on online platforms. The strong presence of cryptocurrencies on online platforms such as search engines and social media networks is a good indicator of its performance projections. If the number of online searches starts to decline for a particular cryptocurrency, it can mean that the demand and interest among the investors are decreasing. On the other hand, if the positive content about a cryptocurrency is lesser than the negative entries, it can also affect the price action.
Economist Negation
The opinion of experts, influencers, academics, and economists carries a lot of weight. When it comes to cryptocurrencies, the price action of a given cryptocurrency can rise or fall depending upon the statements issued by the biggest influencers and experts in the sector.
Lower Highs and Lower Lows
When the price projections for a cryptocurrency continue to print Lower Highs despite good news or continue to reflect Lower lows on account of good news, it means that a bear market is around the corner. In terms of price histograms, Lower Highs mean that the upcoming peak is lower than the last peak, while lower lows mean that the current lows are bigger than the previous lows. Lower Highs and Lower Lows are collectively called a downtrend.
What is Crypto Winter?
There are an aggregate number of internal and external factors affecting the cryptocurrency market at a given time. Therefore, it is usual to see cryptocurrencies printing a mix of red and green candles regularly. Bear markets are considered an important part of the investment market life cycle as per economists who suggest that it is a like reset.
Bear markets can last for short and long periods depending on the underlying factors mentioned above. When a cryptocurrency market decline continues for longer than six months, it is officially classified as a Crypto Winter. The longest Crypto Winter in history was recorded between 2018 and 2020, when the price of Bitcoin was depreciated by 88% while the altcoin performance declined by 90-95%.
Top Techniques to Deal with a Bear Market
Most new investors believe that bull markets are the only time when they can make profits for their investments. However, professional traders understand from experience that the bear market is just another phase and can be managed effectively by using well-prepared and logical trading techniques. Here are some of the best ways to turn a profit despite a bear market run in the cryptocurrency market:
- DCA or Dollar-Cost Averaging
- Shorting Choices
- Avoid precise predictions
- Staking
- Secure Funds out of exchanges
- Diversify your portfolio
- Conduct Research
- Tax-loss harvesting
- Options Trading
DCA or Dollar-Cost Averaging
Dollar-Cost Averaging is a simple yet effective investment technique. Suppose that Mr John wishes to invest $100 in his savings account to purchase a crypto coin X. Rather than investing the full amount at once on buying X coins, Mr John divides his investment fund into $10 pieces that would allow him to purchase $10 worth of X coins at ten different occasions.
Mr John can decide to make a new $10 X coin purchase every new week. It would allow him to monitor the performance of his investment more effectively. In case the price of X coin falls in the 5th week of his investment plan, Mr John can salvage his losses by changing his investment strategy. During uncertain times it is a great idea to use DCA to avoid huge losses.
Shorting Choices
Shorting is a trick that investors use to make profits when the price of a cryptocurrency is down. Take Ms Jane, for example, who borrows $500 from XYZ Bank to invest in X coin when it was selling for $10 each. Shortly after a big acquisition of 50 X coins in Ms Jane’s portfolio, the price of X coins crashed to $5 due to a bear market.
Now, Ms Jane can buy more X coins at a 50% lower price and return the 50 X coins loan to XYZ Bank or its equivalent amount while gaining a profit. Many investors use Shorting to make money when stock prices drop. However, many experts advise against using shorting techniques for a cryptocurrency because it can generate infinite losses and lead to the liquidation of the entire portfolio.
Avoid Precise Predictions
Even the top economists and the best technical market analysts are unable to predict the start and end of a bear or bull market with 100% accuracy. The best way to understand the changing market dynamics is to read about technical factors and research fundamentals. It is not ideal to follow one or two crypto experts or influencers and base investment decisions based on their predictions either.
It is irresponsible to treat the crypto market as a gambling option and base decisions on intuitions and gut feelings. The best practice is to avoid running after a precise and concise bear market bottom date and use the combination of technical and economic indicators to navigate through a bear market. The Dow Theory of Investment suggests that a fundamental remains unchanged until a reversal is confirmed.
Staking
Staking is a great option for cryptocurrency traders to keep earning profits despite the bear market. While traditional banks allow their consumers to earn interest income by opening a savings account, cryptocurrency platforms also offer the same facility to digital currency owners, called staking.
The owners of PoS or Proof-of-Stake cryptocurrencies can pledge their tokens for a decided period to earn APY or Annual Percentage Yield against it. Cryptocurrency exchanges, swaps, DeFi pools, and DAO operators allow the digital currency holders to commit their tokens to improve their liquidity which can also mitigate the investing risks by making funds readily available.
Secure Funds out of Exchanges
In the cryptocurrency market, the phrase “Not Your Keys, Not Your Coins” is quite popular. It is worth noting that many cryptocurrency exchanges offer non-custodial digital wallets for their consumers. It means that the master key for all the accounts is owned by the management of the exchange.
In case the crypto exchange is unable to sustain the pressure from the bear market and folds its business declaring bankruptcy, the users whose funds are locked in the accounts can be lost forever.
Due to the bankruptcy declaration, the investors cannot legally demand the return of their crypto funds. Therefore, it is the best idea to move your cryptocurrency funds to a custodial wallet that grants full sovereignty over your crypto portfolio.
Diversify Your Portfolio
“Don’t put all your eggs in one basket” is one of the best investment advice. The same rule can be applied to the cryptocurrency market as well. At present, there are more than 18 thousand types of cryptocurrencies in the world, as per Investopedia. Rather than betting all your savings on one particular type of cryptocurrency, it is best to diversify your portfolio.
Dedicate a suitable portion of your investment funds to different cryptocurrencies depending on their importance and performance expectations. Professional traders pick their investment choices based on verified fundamentals. It ensures that when one cryptocurrency is experiencing downtime, the other crypto reserves in their portfolio can perform better.
Conduct Research
It is not a good idea to treat the cryptocurrency market as a gambling pit. There are some occasions where an investor can make a bank out of sheer luck, but the odds of such an occurrence are one in a million. When it comes to cryptocurrencies, it is best to start small and try to create long-term investment positions. With some experience and time, the investment portfolio will improve and reduce the chances of losses.
Tax-loss Harvesting
Tax-loss harvesting is a process to qualify for tax cuts on account of incurred losses in investment. For instance, if Mr John invested $100 in X coins and, on account of the bear market, he lost 20% of his investment cost, he can use the losses amount to opt-out of paying a percentage on his other taxable gains. For stock market traders, there is a limit of a 1-month buyback gap to qualify for tax-loss harvesting. However, for cryptocurrency traders, there are no such restrictions thus far.
Options Trading
Options are sale or purchase contracts for a particular asset class about a predetermined timeline. The bigger the time duration of an option, the smaller its profit output. Put options allow an investor to sell an asset or cryptocurrency.
During a bear market, investors can make profits by selling or purchasing put options concerning the bear market start or end. However, it is important to understand that options trading carries high risks and requires a considerable amount of technical knowledge and trading experience.
Conclusion
Bear markets are part and parcel of a healthy investment marketplace. For cryptocurrency investors, it is necessary to keep improving their investment portfolio and learn better trading techniques from experienced traders.
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