Every new piece of technology goes through a learning curve before it can be accepted by the general public and put into widespread use. The invention of blockchain is brand new, and it demands a shift in the established financial infrastructure that has been in place for centuries in order to be implemented. In light of these developments, the question that cryptocurrency investors need to focus their attention on the most is why the market is crashing.
What exactly is digital currency?
In order for the reader to grasp what a cryptocurrency collapse is, they must first comprehend what a cryptocurrency is. The term "cryptocurrency" is a portmanteau formed by combining the words "crypto" and "currency." One can buy and sell goods and services with currencies.
As is evident from the Whitepaper of Bitcoin, the first cryptocurrency, it is a digital alternative for traditional forms of payment such as paper money. In the meanwhile, the term "crypto" refers to the presence of a digital cipher associated with a cryptocurrency. This cipher protects the cryptocurrency from being stolen, altered, or misrepresented in any way.
Blockchains are digital online ledgers that are used to keep these financial data updated and secure. Blockchains are used to issue cryptocurrencies. Blockchains are distinctive in that they do not need the presence of a centralized transaction processing authority, such as a bank or a financial network, in order to complete financial transactions.
Investors now have access, for the first time, to a digital alternative to traditional paper money or a means of exchange. Bitcoin is the innovation that made this possibility possible.
As a consequence of this, it resulted in the development of additional blockchains and cryptocurrencies including Ethereum, Cardano, Solana, Polygon, and others. Each blockchain has the potential to issue several cryptocurrencies simultaneously.
What exactly is a crash in the cryptocurrency market?
At the moment, there are many different kinds of cryptocurrencies floating about in the globe, each of which is connected to its own local blockchain. The native governance tokens for every online DeFi blockchain project, such as games, artwork, lending platforms, staking protocols, liquidity pools, swaps, and others, are now cryptocurrencies. These tokens may be used for a variety of functions.
Every new cryptocurrency issuer works toward the goal of developing a use case for their token so that it may command a higher price on the market. Because of this, a market for cryptocurrencies has emerged, which enables the buying, selling, and trading of thousands of individual cryptocurrency tokens.
Many individuals have the misconception that cryptocurrencies are the same as digital stocks. Cryptocurrencies, on the other hand, more closely resemble commodities or FX in their underlying behavior. These are currencies that are being used for a variety of projects, and the investors are looking to make a profit by either trading them or keeping them in their own.
Due to the fact that cryptocurrencies are able to produce gains through trading, this market has become its own distinct trading industry. A bull run is the term used to describe an appreciation in the value of the bitcoin market. On the other hand, the term "crypto market crash" is used to describe the situation when the bulk of the candles in the cryptocurrency market print red.
Why does the Market for Cryptocurrencies Crash?
The use of technical analysis is common practice among investors when they are attempting to gain an understanding of how to profitably participate in the cryptocurrency markets. However, it is essential for investors to have an understanding of the catastrophe that occurred in the bitcoin market.
Because there are so many factors that might influence the state of the cryptocurrency markets, there is no one correct response to this issue. The following is a list of some of the most prevalent factors that contribute to the downward spiraling of cryptocurrency markets:
Absence of Any Usefulness
The absence of any real-world applications for cryptocurrencies is the primary factor for their recent price decline. If a cryptocurrency does not provide its investors with a suitable use case for the cryptocurrency, then it is unlikely that the cryptocurrency will continue to be popular for an extended period of time. The course of human events is replete with instances in which the cost of a certain good was purposely driven to levels that are incomprehensibly high.
Consider, for example, the Dutch tulip craze that occurred in the 17th century. Because tulips are so uncommon, the Dutch people have a deep appreciation for them; as a result, the price of a single tulip bulb can reach as high as one thousand guilders (or euro) per item.
However, the craze quickly subsided, and those who had participated in the buying frenzy at higher prices wound up suffering significant financial losses. The event is frequently cited as an excellent illustration of a financial bubble. [Citation needed]
On the other hand, there are resources like gold and diamonds that are solely utilized for decorative reasons, yet despite this, they have managed to maintain their status as the most precious assets throughout history.
In the meanwhile, there is empirical data to suggest that cryptocurrencies such as Bitcoin do have a real-world use. But at the end of the day, the value of a financial instrument is only as good as the aggregate trust of the people. This is the case regardless of the type of financial instrument.
Lack of Compliance with Regulations
It is possible for institutional investors to be dissuaded from putting large bets in any given financial scheme by the fact that there are no restrictions in place. When the first banks were established, a significant number of them were unsuccessful and went out of business. The majority of people in this day and age just cannot fathom such a thing taking place.
The existence of financial insurance organizations helps to ensure that customers of banks will not be harmed in the event that their respective institutions fail.
In a similar fashion, the history of stock exchanges is replete with anecdotes of unethical behavior and fraudulent activities in the financial sector that occurred as a result of a lack of regulatory clarity. Some cryptocurrency investors have pointed out that the current lack of confidence in the DeFi industry is also a result of the absence of effective laws. This is something that has been highlighted by a number of cryptocurrency investors.
The supporters of the DeFi markets oppose the establishment of restrictions in order to free markets from the influence of governments on the monetary system and to reduce their exposure to taxation. On the other side, institutional investors are demanding that cryptocurrency rules guarantee the safety and protection of their financial contracts within the law of the state.
Fear, uncertainty, and doubt are all abbreviated as FUD. The condition of a financial market that has been promoted by the majority of players to have a lack of trust in a trading instrument is typically what is meant when the phrase "bear market" is used to describe the situation.
Because certain meme currencies do not come with a lot of usefulness, this eventually leads to a lack of confidence from its investors, which in turn leads to a huge price fall. On the other hand, the majority of cryptocurrencies are also impacted by the current events in the economic background, such as a recession, a downturn in the stock market, inflation, and other similar occurrences.
The Chinese government's decision to restrict Bitcoin trading, the Terra Luna Crash, and the controversy surrounding FTX are just some of the big events that have contributed to a cascading trend in the cryptocurrency markets.
All of these occurrences have the potential to have a negative impact on cryptocurrency investors by inducing a herd mentality, which can then lead to a sudden crash. This type of crash occurs when investors rush to liquidate their trading positions, which increases the amount of supply and selling pressure in the market.
Exchanges for cryptocurrencies, much as stock exchanges for equities trading, are the fundamental building blocks of the markets for such cryptocurrencies. Outside of the blockchains, investors may only buy and sell cryptocurrencies on exchange markets. These marketplaces are the only places where investors can buy and sell cryptocurrencies.
The fact that a large cryptocurrency exchange has been the victim of a hacking attempt that has resulted in the theft of crypto assets worth billions of dollars is, as a result, disappointing news.
The ripple effect has the potential to become out of hand, at which point investors may begin to question the steadiness of the cryptocurrency markets and may begin to remove their assets from the market. Because of this, the market may have difficulties due to a shortage of liquidity.
It has the same impact as when customers of a bank rush to the institution to withdraw their money after receiving unfavorable information about the reliability of the financial institution. One of the original Bitcoin exchanges, Mt. Gox, ended up losing 850 thousand Bitcoins, which resulted in the price of the flagship cryptocurrency falling by twenty percent in 2014.
The Pressure Is On
A sizeable portion of the institutional trading interest that has been shown in the cryptocurrency markets is now held hostage in the form of leveraged trading positions. When institutions borrow money from other financial businesses in order to engage in the cryptocurrency market, they are said to have leveraged trading positions. These accounts are known as trading positions with leverage.
High-frequency trading, often known as HFT trading, is an umbrella term that encompasses this particular mode of business. It is done in order to raise the percentage of the profit.
The use of leverage in trading does, however, come with the need that a certain amount of collateral be kept in the trading account at all times. A margin call may be triggered even if the price of a cryptocurrency only drops by the tiniest of percentages, depending on the needed value of the collateral.
Therefore, the creditor would be required to take possession of the borrower's trading account and give them notice that they must fulfill the minimum criteria of the collateral value. Therefore, if there are a significant number of collateral positions existing in a cryptocurrency market, this indicates that it has the potential to trigger an across-the-board margin call, which would ultimately result in enormous accumulative losses and, subsequently, a lapse of trading positions.
Leveraged positions are often High Frequency Trading, which indicates that they have the potential to cause a significant decline in price and result in significant selloffs.
Problems of a Technical Nature
Another significant factor that can lead to significant losses in cryptocurrencies is the occurrence of technical difficulties. The stock market and other financial instruments have been digitized thanks to blockchain technology, and as a result, they no longer require paper-based documentation. Cryptocurrencies are blockchains.
The problem with digital equipment, on the other hand, is that there is always a chance that they may be hacked. There are also a lot of situations in which hackers can take advantage of the technological blind spots in a blockchain and wind up taking a significant amount of trade currency as a result.
The hacking of Ethereum in 2016 is the most egregious illustration of such an occurrence. As a direct consequence of this cyber assault, 3.6 million ETH currencies were stolen.
At the same time, this led to a split in the blockchain, which was done to ensure that it would be possible to retrieve any tokens that had been misappropriated. According to recent reports, there have been several breaches and vulnerabilities discovered in bitcoin projects.
On the other hand, there are other blockchains, such as Bitcoin's, that have not been subject to any assaults as of yet. When assaults of this nature occur, the faith of cryptocurrency investors in the stability of their respective currencies is damaged, which may lead to selloffs and market collapses if the situation is not addressed.
In the marketplaces for cryptocurrencies, financial scams are commonplace. Scammers and threat actors have always been a problem for investors, whether it is through the misuse of Bitcoin ATMs or through internet hacking attempts.
It is vital to remember that when telephones were first introduced, a wave of on-call cons swept over the people who were installing these first-ever communication equipment in their houses. This was a time when people were more susceptible to being taken advantage of. This is the primary reason that people nowadays often use the word "phony" interchangeably with scams or frauds.
This etymological investigation demonstrates that virtually every new innovation is seen as the proliferation of the devil in contemporary culture. However, it is hard to conceive the version of the world that exists now with e-commerce and digital connectivity without the widespread use of telephones in the previous century.
In a similar vein, the vast majority of individuals living in this generation are not familiar with the operation of blockchains. As a result, individuals are vulnerable to sophisticated cons and swindles that are loaded with cash lures set by con artists.
Other cryptocurrency investors may assume that it is not safe to invest in and hold digital assets as a result of such frauds, which may cause an unprecedented volume of sell-offs and collapses in the market.
The bitcoin market will never be immune to the influence of speculative factors. What ends up happening is that there are some investors at the top who are aware of the market propagation, and these investors take up dominant holdings in the tokens that are expected to achieve tremendous traction in the marketplace. The same can be said of the stock markets, where individuals who are well-connected are the first ones to take up early positions in ventures that are still in the planning stages.
Meanwhile, ordinary investors who are not well-connected wind up getting into the action at later stages, when the prices are already inflated. This is because regular investors tend to invest in smaller amounts. By leveraging various forms of media, such as newspapers and television, stock dealers were able to artificially increase the values of the portfolios they controlled.
As a result of the ease with which the globe may now be connected in real time thanks to the proliferation of social media platforms, it is now much simpler to engage in fake speculation over any particular cryptocurrency.
There are strategies such as "pump and dump" and "rug pulls," in which early investors artificially inflate the values of worthless cryptocurrencies to the maximum potential level, after which they sell their holdings, pocketing the gains while simultaneously driving down the prices.
Within the realm of cryptocurrencies, there have been certain controversies involving insider trading that have been brought to light. On the other side, crypto whales have the potential to retain a significant amount of influence in the market due to their large percentage of the cryptocurrency, allowing them to drive prices lower at their whim.
The frequent volatility experienced in bitcoin markets is another significant cause that is viewed as a drawback for the cryptocurrency markets. When compared to traditional markets and trading instruments, the cryptocurrency market is characterized by a greater number of frequent price movements.
Because of this, investors consider them to be high-risk choices for trading. It is one of the primary reasons why the large participants in the market and institutional investors recommend to the vast majority of their customers that they do not take up positions in cryptocurrencies.
This can lead to a lack of professional trading interest in the cryptocurrency trading market, which can result in the crash of this market instrument if it is not addressed.
There is no regulation in place within the financial markets that stipulates investors are required to take on greater risks in order to maximize their returns. Despite this, the vast majority of people around the globe continue to hold similar beliefs. This implies that the intrinsic feature of greater risks in cryptocurrency markets might lead to them experiencing large profit returns if they are successfully navigated.
On the other hand, trading strategies that are designed for shorter time frames, such as Day Trading, Scalping, and Momentum Trading, amongst others, benefit from characteristics such as increased volatility and improved liquidity. These aspects are important.
The Trading of Derivatives
Derivatives trading is an improbable element that might potentially play a part in the market for cryptocurrencies collapsing, but it's possible it could happen. Trading certificates known as derivatives give investors the ability to monitor the performance of an underlying asset without actually having to possess that item directly. The derivatives may be broken down into a wide variety of components, including forwards, options, futures, DeFi swaps, and many more.
In the event that there is a widespread liquidation of leveraged derivatives positions, it is possible that this may result in a precipitous drop in the price of cryptocurrencies like Bitcoin.
However, if the price of the total number of perpetual contracts for Bitcoin rises beyond its spot price, this can set off a large selling pressure that is carried out by trading bots in a matter of milliseconds.
Because of a sudden influx of a vast amount of Bitcoin supply on the cryptocurrency exchanges, prices have fallen, which may lead to a crash if they continue to fall precipitously. This decline is caused by a flush of massive Bitcoin supply.
How to Avoid Losing Your Cryptocurrency When Prices Drop
Now that the appropriate questions have been identified, it is time for investors in cryptocurrencies to begin searching for answers to those issues. It is impossible for a single retail investor to dominate the whole market. Nevertheless, the following are some preventative steps that any investor may take to safeguard their cryptographic asset portfolio from exposure to risky conditions:
Spread Your Money Around
When it comes to investing in cryptocurrencies, the necessity of maintaining a diversified portfolio cannot be emphasized enough. If an investor plans to believe that they can generate significant profits by investing in just one currency, then their odds of success are close to zero and even lower than fractional divisions.
On the other hand, if investors are able to disperse their trading money among a number of different prospective cryptocurrencies, they are able to hedge their trading risks and reduce the overall impact they have on their portfolios.
Investors in cryptocurrencies should only put up the maximum amount of capital that they can afford to lose into the market. This is especially true for those individuals who are just beginning their careers as investors. A large number of people are influenced by market speculation, and as a result, they wind up building leveraged positions in the market without first gaining any knowledge of the market's fundamental or technical analysis.
As a result, those who invest their money need to ensure that they have done their homework and act with extreme caution.
Your trading position may be increased using the DCA approach at certain time periods. It may imply that the investors have the opportunity to acquire knowledge regarding the trading positions as they grow in size. Traders can obtain a higher degree of control over their trading positions and be better prepared to quit trading in the event that unforeseen market changes occur.
This warps our understanding of how the world really works. For investors in cryptocurrencies, this indicates that they must maintain their long-term cryptocurrency investments despite of the changes that are now occurring in the market.
There are a variety of long-term trading strategies, such as turtle trading and others, in which investors are instructed to hold on to their positions for an extended period of time in the hopes of realizing exponential returns at the conclusion of a trading period that lasts five to ten years or longer.
The cryptocurrency and blockchain industries are currently receiving more attention from people all around the world than any other sector of the technology industry. The conversation has contributed to an increase in the daily conversions, and groups online that are only dedicated to cryptocurrencies are working hard to maintain a bullish attitude in the market.
However, it is important for each and every investor to have an understanding of the causes that might lead to a crash in the cryptocurrency markets and to base their trading decisions on the events that have transpired.