Crypto
Bybit Learn
Bybit Learn
Beginner
Jun 6, 2022

Crypto Crash: 8 Reasons Why it Happens

The cryptocurrency market has always been known to be wildly volatile, with rises and falls in prices as dramatic as a rollercoaster ride. The recent May meltdown is one of the greatest crypto crashes in years. It’s left many crypto investors high and dry — especially if you're one of those who have poured their life savings into crypto investments. The bad news of this latest drop can turn your life upside down; you're not sure what happened or why, but you're panicking and wondering if you should sell everything.

Put a hold on that thought, and stay calm. You’ll first need to find out more about the possible reasons why crypto is crashing before you make any irreversible decisions.

What Is Cryptocurrency?

A cryptocurrency is a digital currency that’s secured by cryptography, making it nearly impossible to counterfeit or double-spend. Cryptocurrencies are decentralized, meaning they aren’t subject to the control of governments or financial institutions around the world.

The popularity of cryptocurrencies has grown in recent years, due to their potential for investment gain, their use as a hedge against traditional fiat currencies, and for peer-to-peer online payments. Some experts believe that cryptocurrency will eventually replace fiat currency altogether, but this remains to be seen. In the meantime, crypto remains a volatile but potentially lucrative investment.

8 Reasons for a Crypto Crash

Now that you’re up to speed on what a cryptocurrency is, here are eight of the most common reasons for a cryptocurrency crash.

1. Minimal Utility

Granted, cryptocurrencies such as Bitcoin have the potential to be used as a form of payment anywhere in the world. After all, we’ve recently seen increased levels of adoption with countries such as El Salvador even announcing that Bitcoin would be accepted as legal tender. But for the most part, cryptocurrencies aren’t widely used as a means of payment, but rather are held as investment commodities.

This limited utility is one of the main reasons cited by experts for crypto crashes. If there's no real-world use for a digital asset, then it's likely its value will eventually crash. After all, there's only so much speculation that can prop up a currency with no actual use.

In addition, studies show that only a paltry 28% of small businesses accept cryptocurrencies as payment for goods and services. Compared to other payment options, like credit cards (80%) or PayPal (61%), crypto transactions are still in the minority.

2. Cryptocurrency Regulation

Another major factor that can cause a crypto crash is government regulation. Over the years, select jurisdictions have cracked down on crypto, but its implications have been most fully felt with China’s aggressive crackdown.

In September 2017, the Chinese government imposed a nationwide ban on initial coin offerings (ICOs), which are a form of crowdfunding for crypto projects, and also ordered all exchanges to cease trading activities. This caused the value of Bitcoin to drop by over 20% in just a matter of days. In June 2021, China was at it again, putting its foot down on all crypto-related activities. This led to multiple crypto miners shutting down their businesses. As China miners contribute to 65% of mining activities worldwide, ramifications were unavoidable. After enjoying an all-time high of $65,000 for the month of April, prices plunged to below $30,000 in June.

Although the Bitcoin network has since recovered, there’s no telling what other cryptocurrency regulations may be imposed in the future, which could potentially lead to another crypto crash.

Other countries that have stringent laws when it comes to crypto include South Korea, which implemented several restrictions on crypto trade in 2018. Egypt, Iraq, Bangladesh and Algeria have also placed harsh regulations on crypto-related activities.

In most cases, when a regulatory body announces that it's going to crack down on cryptocurrencies it can lead to a sell-off, as investors worry about what the new rules will mean for the future of the crypto market.

3. FUD (Fear, Uncertainty and Doubt)

Another common factor that can lead to a crypto crash is FUD, which stands for fear, uncertainty and doubt. As some cryptocurrencies (such as meme coins) do not have much inherent value on their own, their values are very much tied to investor sentiment. If there's negative news about a particular cryptocurrency or company, investors may sell, wishing to avoid potential losses. And as crypto is closely intertwined with macroeconomic events, a stock market crash, inflation, or any catastrophic world event can cause a crash in crypto prices.

The colossal loss of $300 billion in the crypto crash in May 2022 is a perfect case of FUD. The current overall bearish stock market and the global economy will naturally lead people to be more conservative in their investments. And with crypto being a volatile asset that’s highly susceptible to broader market swings, people will feel FUD when it comes to risky investments. On top of that, over a span of just a few days last month, the algorithmic stablecoin TerraUSD and its sister currency, Luna, entirely collapsed. This created a cloud of fear among crypto investors, causing prices to dip even further for all other cryptocurrencies.

Another notable example was when Tesla CEO Elon Musk announced in May 2021 that his company would no longer accept Bitcoin as payment for its electric vehicles. This caused the price of Bitcoin to drop by over 10% in a matter of hours.

Similarly, if there's any news about hacks or security breaches, that can also trigger a sell-off, as investors lose confidence in the safety of their investments.

4. Exchange Hacks

Crypto exchange hacks can also contribute to crashing crypto prices. If a major exchange is hacked and investors lose their funds, that can trigger a sell-off as people lose confidence in the safety of cryptocurrencies and rush to trade in their digital assets for stable fiat currencies.

The infamous Mt. Gox hack in 2014, for instance, led to the loss of 850,000 bitcoins, worth over $470 billion at that time. This in turn led to a 20% fall in Bitcoin prices. After all, exchanges are where people often buy and sell cryptocurrencies, so if there's a security breach, that can lead to significant losses and panic across the crypto market.

5. Cascading Sell-Offs Caused by Margin Debt

As the popularity of cryptocurrencies continues to grow, so does the amount of money that investors are willing to put into digital assets. While this can provide a boost to the market and lead to increased trading activity, it can also create the risk of a crypto market crash. One way this can occur is through margin debt.

Margin debt is incurred by an investor who performs margin trading — that is, borrowing funds, or leveraging from a broker or an exchange, to trade. When investors borrow money to purchase additional coins, they increase their potential profits — but also their potential losses. The greater the leverage, the greater the effect in the price drop when assets get liquidated, creating a cascade selloff effect leading to a plunge in the crypto prices.

6. Technical Issues

Sometimes, a crypto crash can be caused by technical issues. For example, a problem with the technology underlying a particular cryptocurrency can lead to a sell-off. This was the case with Ethereum in 2016, when a hack led to the loss of 3.6 million Ether, worth $50 million back then.

Similarly, if there are any issues with popular wallets or exchanges, that can also lead to a sell-off as investors lose confidence in the safety of their digital currencies.

Even though Bitcoin is renowned for pioneering the crypto revolution, and Ethereum for its smart contract platform, these first- and second-generation cryptocurrencies continue to be weighed down by inherent technical issues and a lack of scalability.

With over 17,000 digital currencies available today, innovative dilution of legacy cryptocurrencies is inevitable. Since Bitcoin and Ethereum dictate the entire market, any major technical setback could lead to a domino effect and a sharp sell-off across the market.

7. Crypto Scams

Unfortunately, there are always people looking to take advantage of investors in the crypto market. From the rug pull in the Squid Game coin scam to the pump and dump scheme of FaZe Clan, crypto enthusiasts were targeted by several high-profile scams throughout 2021, with reports showing scammers got away with over $14 billion worth of value from the market.

Given the high-tech nature of cryptocurrencies, it can be easy for scammers to create fake wallets, exchanges, and even digital currencies. These crypto scams can often lead to investors losing their hard-earned money, which can trigger distrust in the overall markets of cryptocurrencies and everything blockchain-related.

Scams in the crypto space not only lead to investors losing millions of dollars or more, but also contribute to a general increase in skepticism and FUD around cryptocurrencies.

8. Market Manipulation

Another factor that can cause a crypto crash is market manipulation. This is when someone tries to artificially manipulate the market by spreading FUD or buying and selling large amounts of a particular cryptocurrency. This can often be done by a group of people or entities working together, known as whales.

Crypto whales are investors with a large amount of money to put into the market, and they can (intentionally or not) often have a significant impact on prices. For example, if a whale buys a large amount of Bitcoin all at once, that could lead to an increase in the price. However, if they then sell all of their Bitcoin at once, that could lead to a sharp decrease in the price.

While market manipulation can be difficult to spot, it's important to be aware that it does happen in the crypto world.

How to Protect Your Assets

Now that you know some of the main reasons why crypto crashes happen, you may be wondering what you can do to protect your investments in case of a crash.

Here are a few tips:

Diversify your portfolio: If you invest in only one asset, your risk is amplified. To reduce your risk, diversify your portfolio. This means investing in a variety of different cryptocurrencies, as well as other forms of investment, rather than putting all your eggs in one basket.

Don't invest more than you can afford to lose: It's important to remember that the cryptocurrency market is still very volatile, and crashes can happen at any time. As such, don’t invest more money than you responsibly can.

Dollar-Cost Averaging: This is an investing strategy whereby one regularly invests a fixed amount of money on an asset each month, spreading out the investment over time. Regardless of the market’s ups and downs, investments are continuously made so that you lower the average cost of your purchase as compared to making a lump-sum purchase when the market price is high.

HODL: One of the most popular crypto phrases is "HODL," originally a typo, which has come to stand for "hold on for dear life." This phrase is often used during times of market volatility to encourage investors to hold onto their coins, rather than sell them in panic. After all, the volatility of the market means that when crypto prices fall, they’ll eventually rise again, as evidenced by the dramatic movements of Bitcoin over the years.

While there's no guaranteed way to fully protect your assets during a crypto crash, following these tips can help you minimize your losses and ensure that you're prepared for market volatility.

Closing Thoughts

Cryptocurrencies have brought life-altering gains to many investors. However, with every major market rally comes the potential for a devastating market retracement.

For most onlookers, these volatile market swings are a cause for concern. But for those who have done their research — and are prepared for the crypto market’s ups and downs — these sudden price changes present an opportunity to buy assets at discounted prices.

Whether you’re new to the world of cryptocurrencies or have been investing for years, it’s important to understand the various factors that can lead to a crypto crash. By being aware of these risks, you can make sure that you’re prepared for market volatility and ready to take advantage of any opportunities that may arise.