What to do When the Cryptocurrency Market Crashes?
When the crypto market is bearish, should I buy or sell? What are certain things we can do?
Despite high amounts of smart money pouring into the cryptocurrency market, and high levels of Bitcoin accumulation, Bitcoin’s crashes are still terrifying and seemingly unpredictable.
More recently, the Evergrande debt crisis and dips in the S&P 500 and Dow Jones has caused the cryptocurrency market to fall further.
Moreover, Bitcoin options show substantial put option interest of BTC at 40k strike price. Should the price drop to 40k by the end of the month, Bitcoin price may further dip with the option’s expiration date.
With all these in mind, how do we prepare for a crypto bear market? What can I do to prepare when the market crashes?
Diversify your portfolio
The first thing they teach you in business school is that we should always diversify. Tiktok gurus would have you believe that you would just need one or two well-performing assets in your portfolios.
However, according to statistics, you’ll do better in the long run if you were to diversify than if you didn’t.
Image credits: Seeking Alpha
Of course, there are risks that are non-diversifiable, known as systematic risks (or “Beta” in Finance parlance). These are inescapable simply because of the nature of risk and returns. However, the more you are able to diversify, the lower your risk/standard deviation will be. These aren’t just nice graphs imagined by some guy on wall street. No, these are actually tried and tested mathematical curves that have been derived from historical data.
How to diversify?
Now that you are convinced that we should diversify, let’s see how we can diversify. To diversify, consider a larger variety within cryptocurrency, and also consider other asset classes (Commodities, Indexes, etc.).
So instead of purchasing Ethereum and other Tokens which are from ERC20, consider investing in Bitcoin, or Cardano, which are more insulated to shocks in Ethereum. Fortune Coin and other tokens that are adopting their own chain could also be considered. For some ideas, consider these 10 alternative coins.
You could also invest outside of cryptocurrencies. You could consider gold, the Japanese Yen and other traditionally safe-haven assets to diversify.
Once you are well diversified, your overall risk should be lower. Any sudden movements in one asset could be compensated with the rise in another asset.
Hedge your portfolio
Hedging is a way to decrease the risk of sudden movements in price. This can be done through purchasing assets that have an inverse correlation to cryptocurrency, or by purchasing options and futures.
Options
There are two main types of options — put and call. To hedge against a market crash, we will focus on put options. Put options give you the right but not the obligation to sell an asset at a specific time and price.
For instance, if I think that Bitcoin will drop below $40k by the end of October, I will buy a put option for $40k, expiring in December. In this case, $40k is called the strike price. Even if the price drops below $40k, I can still sell my BTC at $40k and earn a profit.
Image credits: Investopedia
However, there is a cost of purchasing a put option, called the options premium. In order to break even, the price of Bitcoin at expiry has to be lower than the strike price minus the options premium. Therefore, if the option premium is $1k, I will have to make sure that the price at expiry is $39k to break even.
Let’s say BTC price drops to $38k, I can sell my BTC at $40k and make a $1k profit (remember that there is a $1k cost for options premium).
This is a great tactic if you intend to hold BTC for the long haul. Purchasing put options will allow you to profit from market crashes and minimise your portfolio loss.
Inverse correlation assets
Another way to hedge against downwards price movements of cryptocurrencies is to purchase assets that have inverse correlations. This means that these assets tend to do well when cryptocurrencies do badly.
This academic paper suggests that Gold may actually be slightly negatively correlated to BTC returns when BTC are downward, and positively correlated when BTC returns are upwards. As evident in the graph below, the price of bitcoin and gold seem to follow an almost similar fashion except in dips.
Image credits: Capital.com
This means that when Bitcoin is crashing, it may be a good idea to purchase some gold commodities to hedge your Bitcoin exposure.
Hold
A popular saying goes “Time in the market beats timing the market”. In fact, speculative traders tend to do worse off than those who hold for the long haul. The S&P 500 returns an 11% yearly return. However, some funds may fail to even make 10% a year with their active fund management.
The S&P 500 index shows a steady increase over the year.
Bringing this back to crypto, your best shot may just be to hold your coins. Trying to time when to buy or sell may just lead to bad mistakes. However, if you do intend to sell, you can try selling them small portions at a time.
Buy more
If you have cash lying around, you can consider buying up crypto if the market tanks. Buying up crypto at a lower price will allow you to consolidate and beef up your portfolio when the market heats up again.
Buy the right way
However, you should buy it the right way. Firstly, consider averaging up or down when you buy (dollar-cost averaging). This means that you should buy it at bits at a time instead of purchasing one lump sum at a go.
Say you have $8000 left, purchasing the asset at regular intervals of one month as seen in the orange circle below, provides a return of 4% on investment. However, if I were to invest a lump sum at the start, it returned 0% after 12 months.
Image credits: Capital.com
To build on this further, there are a few general statistics. In a 2-year time frame, Sundays are generally correlated to a dip in prices, while the price generally increases over the week. Monte Carlo simulations of those who dollar-cost average once a week tend to perform better than if done monthly.
Buy coins with an underlying value
Some coins such as Bitcoin are valuable only because people agree with its value. That is, it possesses value due to its network effect. However, coins such as Ethereum and Fortune Coin have underlying value.
The Ethereum blockchain is used to run applications, tokens, and many more. While you are not able to claim physical assets, there is a strong utility attached to Ethereum.
Similarly, Fortune Coin seems to present an underlying value. You can purchase food and products using Fortune Coin on the Old Village Cafe E-commerce site. Because there is a use for Fortune Coin, its market price may be less volatile than other cryptocurrencies.
The value of Fortune Coin has increased 400% since its Initial Coin Offering in May 2021. We only expect that the injection of smart money — with the completion of its own native smartchain — to boost the price of the coin.
Conclusion
Market crashes can be a very scary thing. While it is difficult to ascertain when a crash will happen, we can prepare ourselves by diversifying our portfolio, hedging our assets, holding, buying when the price falls, and buying coins with an underlying value.
This article is meant for education only and not meant as financial advice. Please perform your own research before making any investment decisions.
