Recent cryptocurrency downturns have wiped out huge amounts of wealth.
Cryptocurrencies have had a rough start to the year. As of Jan. 26, Bitcoin (BTC) had lost about 20% in value year to date, and Ethereum (ETH) and Binance Coin (BNB) dropped about 30% and 25%, respectively, in that period, despite a late surge higher. These are the three biggest cryptocurrencies in circulation by market capitalization – not counting the stablecoin Tether (USDT), which is tied to the U.S. dollar. This isn’t the first time crypto has taken a big dive. From mid-May to mid-July 2021, cryptos went through another big drop, and Bitcoin fell more than 45%. Despite the volatility, many investors are still interested in cryptocurrencies. According to Vin Narayanan, vice president of strategy at Early Investing, “As crypto adoption increases, it’ll become more stable.” Until then, however, investors may want to know what to look for so they don’t get burned by crypto crashes.
Crypto data firm CryptoQuant’s BTC leverage ratio hit all-time highs in early January, meaning more investors are taking on risk in the crypto space. Just like in traditional markets, crypto investors will often use debt to finance purchases of futures. This can be a way for miners to hedge against future price drops in the coins they’re mining.
Lack of liquidity in cryptocurrency markets
The biggest problem the crypto markets face when leveraged investors liquidate a large portion of their assets is the overall liquidity of the markets. Unlike in the stock market, there aren’t always a bunch of buyers waiting to snatch up unloaded coins. This is part of the reason why crashes tend to occur over weekends for crypto.
When China banned crypto mining in June 2021, “miners had to move to other jurisdictions that were more miner-friendly,” Peters says. The implications for crypto investors were that “we saw a significant decline in the network hash rate.” In the crypto world, a hash rate is the number of calculations that can be performed per second. These calculations are what allow the miners to produce the coins they’re mining, and they affect a coin’s price. When prices decline, the hash rate declines. It’s been theorized that the opposite holds true, as well. This is often because miners are paid in cryptocurrency. But this also means that when governments clamp down on mining through regulations, the overall price of cryptos can decline.