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Why Do Cryptocurrencies Crash?

Cryptocurrencies are inherently volatile, as 2022 has demonstrated. Here are some reasons.

Too much leverage is being taken on by cryptocurrency investors.

The BTC leverage ratio of crypto analytics firm CryptoQuant hit all-time highs in early January, indicating that more investors were willing to take on risk in the crypto market. Similarly to traditional markets, crypto speculators will frequently utilize loans to fund futures purchases. Miners can use this to protect themselves against potential price declines in the currencies they’re mining. These levels of leverage, according to Simon Peters, senior account manager at eToro, “may portend turbulence in the short term” for cryptocurrencies.”Price drops might induce liquidation of long-term assets,” Peters argues of any asset class. Prices may then fall even lower as futures holders begin to liquidate their bets as prices collapse. It’s a cycle akin to the stock market crashes of 1929 and 2008. These kind of collapses, on the other hand, are particularly perilous for markets with little liquidity, such as cryptocurrency.

In bitcoin markets, there is a scarcity of liquidity.

When leveraged investors liquidate a major amount of their holdings, the main issue the crypto markets confront is general liquidity. When a whale — an investor with a huge holding in a particular asset – sells massive sums of cryptocurrency, for example, it might flood the market.The coins just flow into the larger market, resulting in a surplus of supply and low demand.

Cryptocurrency regulation is a hot topic right now.

“Miners had to travel to other countries that were more miner-friendly,” Peters adds, when China outlawed crypto mining in June 2021. A hash rate is the amount of calculations that can be completed per second in the crypto industry. These computations allow miners to manufacture the coins they’re mining, and they have an impact on the price of a currency. When prices fall, so does the hash rate. It’s been proposed that the contrary is also true. This is frequently due to the fact that miners get compensated in bitcoin. But this also implies that if governments impose limitations on mining, the entire price of cryptos may fall.

Security flaws in cryptography are creating concern.

Other variables that might create a crypto meltdown, according to Peters, are blockchain and network security. This type of disaster would follow the same pattern as regulatory interruptions caused by government actors. For example, if it looked that Bitcoin had a security issue, it would reduce the motivation to mine it, lowering the hash rate and lowering the total price. “There will only ever be a certain quantity of Bitcoin.” Unlike stocks, which are backed by assets, the value of most cryptocurrencies is solely determined by investor emotion.The problem for cryptocurrency investors is to select those with limited supply and long-term appeal, according to Dan Kemp, global head investment officer at Morningstar Investment Management.

Volatility is being caused by cryptocurrency influencers.

When it comes to mood, Peters warns cryptocurrency investors that “crypto enthusiasts and important influencers can tweet and induce a capital influx.” We’ve already seen this with Elon Musk’s backing for Dogecoin. Tweeting, on the other hand, might have the opposite impact. This is due to the fact that the value of this asset class is reliant on investor mood, as well as the lack of liquidity in crypto. As the market fluctuates, traders may utilize stablecoins to simply move in and out of other crypto holdings.

Correlations between cryptocurrency and the stock market.

Cryptocurrency should be free to float on its own, separate from the rest of the market. However, as the year 2022 has shown, this isn’t always the case. “Because of traditional acceptance, crypto markets have gotten more linked with traditional markets in recent years. Some individuals believe that cryptocurrency and the stock market have a strong relationship “Peters agrees. Crypto, which was previously thought to be the world’s newest hedge against interest rates and inflation, is proving to be significantly more tied to general markets than early users anticipated. Take a look at the crypto market’s 45.3 percent drop year to date through May 12 vs the S&P 500’s 17.5 percent drop.

The fact that this drop coincides with rising rates doesn’t assist to prove that the two are unrelated. “Crypto collapses are part of investing in crypto,” Narayanan argues. Investors must assess their time period for keeping digital assets as well as their ability to withstand market downturns.

Conclusion: Cryptocurrency falls for six reasons:

  • Lack of liquidity in cryptocurrency markets.
  • Crypto investors taking on too much leverage.
  • Cryptocurrency regulation is a term that is used to describe a set of rules that governs the use of cryptocurrencies.
  • Crypto security flaws are creating concern.
  • Volatility is caused by cryptocurrency influencers.
  • Correlations between cryptocurrency and the stock market.

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