If there’s one word that describes Bitcoin and cryptocurrency, it’s volatile. Crypto prices soar and then seem to crash almost as quickly, while rumors, sentiment and fundamental developments are quickly factored into the market. Even seemingly reliable stablecoin TerraUSD has plunged as concerns quickly developed about its solvency, and the Treasury Department is citing the risks that cryptocurrencies could cause to the broader economy, calling for heavier regulation of them.
For example, Bitcoin was skyrocketing in November 2021, hitting an all-time high of nearly $69,000. But less than three months later the cryptocurrency had lost nearly half its value, plummeting to around $35,000. Lately, it's been trading under $30,000.
That volatility attracts traders looking to make a profit, but it’s nerve-wracking, especially for new investors looking to get started. And traders can expect plenty more of this volatility in the future, as new cryptocurrencies emerge and others fall by the wayside.
With cryptocurrency so extremely volatile, what should investors be doing to manage their risk?
5 things to do when cryptocurrencies plummet
Scared by a plunge or thrilled at the prospect of buying in cheaper? Either way, here are five things that you need to do when cryptocurrency prices crumble.
1. Stay calm
Whether you decide to sell your cryptocurrency or see a dip as an opportunity to buy more, you need to act with a cool head. Making emotional decisions, especially when trading, rarely results in anything good happening. So, before you rush into the market in a panic, you’ll want to reflect on why you’re trading crypto in the first place.
Are you investing because you believe in the long-term opportunity?
Or are you here to make a quick buck on short-term trading?
The answer to these questions can help guide you to the proper decision. In either case, you’ll want to act in accordance with your own goals. In other words, if you believe in the long-term opportunity, think with that mindset. If you’re here for a quick trade, think with that mindset.
2. Assess the situation
Is there news driving the trading price of Bitcoin and other cryptos? It’s possible that there’s fundamental news that’s shifted the market’s sentiment and it’s not just price action or rumor driving sentiment.
In 2021, actual developments hurt prices. China’s move to ban financial institutions from providing crypto-related services was a further clampdown, since the country had already banned crypto exchanges in 2017, though it hadn’t prohibited individuals from owning cryptocurrencies. Then late in 2021 the Federal Reserve decided to reduce liquidity in the financial system, and many cryptos have been on a significant downturn into 2022.
In May 2022, the stablecoin TerraUSD plummeted as traders engaged in an old-fashioned “bank run,” as they feared that it didn’t have the crypto assets to back its peg to the dollar. This news spilled over into other crypto markets, as traders worried that selling would beget more selling.
So, these moves have been further significant blows to the burgeoning market, which had been enjoying significant capital inflows.
3. Remember that volatility is the name of the game
Cryptocurrency is volatile by nature. Because crypto generates no cash flow, traders have to rely on changes in sentiment to drive the price. That means the market can swing between rabid optimism, as it did in early 2021, to pessimistic despair, as it did a few months later. The furor around the Coinbase IPO in 2021 helped drive positive sentiment to crypto, while the reduction in monetary stimulus drove pessimism at the end of 2021 and start of 2022.
So when you have an asset that’s driven by sentiment, the emotions of traders propel the market. That’s true in the case of stocks, too, but they also may have a real stream of growing cash flows from their issuing company to accelerate them higher.
This volatility is exactly what draws professional traders, who use high-powered algorithms to make sophisticated trades, something that “mom and pop” traders don’t typically have the advantage of using. Traders like volatility since it gives them a chance to make money — that’s Wall Street’s game.
4. Evaluate the future
Analyze how the fundamental situation could play out for crypto, given new developments: Will governments get tougher on it? Will they encourage wider adoption of it? Will new regulations help rather than hinder the cryptocurrency market? What else might drive the market?
Is China’s move to ban crypto a harbinger of things to come? Maybe. India had been mulling the idea of banning cryptocurrency, while the Russian central bank has also voiced opposition to it, too. But other countries, including the United States, are exploring how to regulate cryptocurrency instead of prohibiting it outright. A couple countries, namely El Salvador and Central African Republic, have even made it legal tender.
How other major countries proceed remains to be seen, but it’s clear that cryptocurrencies face real threats in the form of regulation, including regulation that could literally put them out of business. As crypto gains traction, it risks becoming a victim of its own success.
It doesn’t help that crypto is used as part of ransom attacks and other criminal activities.
Therefore, it’s not out of the question that the utopian dreams of crypto purveyors are simply legislated out of existence. Of course, the political implications are but one facet of their future. Crypto faces other significant hurdles, including the financial and environmental costs of “mining” them.
Another risk: because of their volatility, many cryptocurrencies are mostly unusable as currency and it’s “being sold to people who have no intention of using it” as currency, as I discussed on Cheddar TV. And finally, IRS rules on taxation make crypto unwieldy as a payment system.
5. Determine how to act
After you’re done cooling down and have assessed the situation and what it means for the future, you’ll want to consider how to act.
Are the risks really opportunities in disguise? If you see it that way, you may want to continue holding your position or use a dip in the price to invest more.
Are the risks likely to persist or even grow worse? If so, you may want to take your losses now and stay out of the game for the future.
Is the situation too murky? If it’s tough to see the way ahead, you may consider splitting the difference, selling some of your position today while still having potential upside tomorrow.
Whichever way you go, you’ll want an action plan that reflects your view on the potential risks and opportunities of cryptocurrencies. But it’s worth noting that some of the world’s smartest investors won’t touch cryptocurrencies and strongly caution you about them, too. Legendary investor Charlie Munger, vice chairman of Berkshire Hathaway, said, “I admire the Chinese, I think they made the correct decision, which was to simply ban them.”
Munger is also on record with the following statement about cryptocurrency: “To me, it’s just dementia. It’s like somebody else is trading turds and you decide you can’t be left out.”
Alternatives to cryptocurrency
Cryptocurrencies are highly volatile and speculative, and many investors don’t feel comfortable putting much, if any, money in them. The good news for investors is that they have alternatives to cryptocurrency that offer attractive long-term returns:
Individual stocks. If you’re willing to do the analysis and continue tracking the company, you can make very good returns by investing in individual stocks such as Amazon or Apple.
Dividend stocks. If you’re looking for a cash payout as part of your investment, you can buy dividend stocks. These tend to be less volatile than stocks overall.
Index funds. If you don’t want to do the work of finding individual stocks but still want high returns, then a good alternative is an index fund. An index fund owns stocks or other assets and is designed to track a specific collection of stocks (such as the S&P 500).
REITs. If you’re looking for a healthy cash payout, REITs are another alternative to dividend stocks. REITs own and operate real estate and have a good long-term track record of returns. You can even buy a fund, so you don’t have to pick individual REITs.
Those are some of the highest-potential alternatives to cryptocurrency.
Bottom line
A plunge in the cryptocurrency markets may have you feeling rattled. Use it as a wake-up call to re-assess why you’re involved in the market to begin with. What opportunities and risks does it present?
While Bitcoin, for one, has rallied back hard following previous major declines, there’s no guarantee that it would do so again, especially if it’s facing serious existential questions as countries ban the use of it and potentially the ability to even own it. And that’s the kind of real risk that an investment can be destroyed by or profit from, if the reality is less severe than the expectation.
