Do crypto exchanges go bankrupt?
If there is one word that describes Bitcoin and cryptocurrency, it is fleeting. Crypto prices are rising and appear to be crashing almost as fast, while rumors, sentiments and basic developments are rapidly being brought to market. In just a four-day period in early June,
This volatility attracts traders who want to make money – but it’s nerve-wracking,
With cryptocurrency so extremely volatile, what should investors do to manage their risk?
Let’s first talk about cryptocurrency and the reasons for it. The line has stopped going up. The all-time highs of cryptocurrencies in 2021 now seem like a distant memory, and the cryptocurrency in 2022 has seen that large digital assets have returned the gains they achieved during their historic bull run.
So why does crypto crash? It is important to remember that in this last cycle, cryptocurrencies are not alone. The stock market has also suffered from a downturn, as US politicians try to tame inflation by tightening the money supply and raising interest rates.
However, Crypto has been particularly hard hit as investors have moved away from risky assets. And the decline in cryptocurrencies puts stress on institutions and other major players in the field that made investments near the top of the market.
Crypto-investment has never been for the faint of heart. Digital assets are quite volatile, and such fluctuations have occurred before. Although the factors that drive each cryptocurrency are different, it can be helpful to remember some established investment principles.
Recently, the world’s largest crypto exchange, Binance, suspended Bitcoin withdrawals due to severe network congestion. Their team suggested users use BTC-BNB or BTC-ETH trading pairs to exchange Bitcoin and withdraw until they fix the problem.
On the same day, Celsius Network, a lending company for cryptocurrencies, announced that it would stop all withdrawals and transfers between accounts due to extreme market conditions, in the latest sign of pressure in the crypto industry. So, what does all this indicate about the intention of the exchanges? What should investors do in such a time, and should they forget their money?
Why does it hurt the stock markets?
Crypto’s price movements can be affected by interest rates, inflation and other macroeconomic factors that can affect how confident people feel about investing their money in risky alternative assets. As interest rates rise, savings accounts become more attractive, and some people may be more comfortable placing their money where they can get predictable returns.
And when prices fall rapidly as they did in the spring of 2022, it could intensify market pressure by forcing some investors to release money so they can meet other obligations.
Another factor that can drive investor pessimism and can lead to cryptocurrency is the actions of governments from regulators around the world.
As interest in cryptocurrencies has grown, government officials are considering what the technology could mean for monetary policy, security and the environment.
China has been particularly aggressive. In 2021, for example, prices fell after the Chinese government declared cryptocurrency transactions illegal and said that foreign exchanges are not allowed to do business with people in China.
The downturns in 2022 come as the crypto market has prepared for action from the US government on several fronts. While monetary policy makers are increasing interest in trying to curb inflation, the Biden administration has ordered federal agencies to develop detailed plans for cryptocurrency.
Literally, most industry experts have noted that crypto exchanges stop withdrawals and deposits as they run out of liquidity. Stock exchanges do not have cash even to a fraction of the estimated value of cryptocurrencies, which they have in their digital wallets on behalf of investors. Since the stock exchanges cannot liquidate their holdings even at their written-down values, they are trapped.
Many crypto exchanges keep some Bitcoin or Ethereum in their reserves or cold wallets for long-term storage, and you know it’s as if they continue to circulate the same cryptocurrencies with new users. But every time there is a situation like this where people want to withdraw their cryptographer at once, it takes a toll on the entire matching system. Another reason is that the stock exchanges currently have 2.4 million Bitcoins out of 19 million in circulation. So this clearly indicates that the stock markets are drying up.
So what should investors do now?
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Stay calm
Whether you decide to sell your cryptocurrency or see a dip as an opportunity to buy more, you need to trade with a cold head. Making emotional decisions, especially when shopping, rarely results in something good happening. So before you rush into the market in a panic, you should reflect on why you trade in crypto in the first place. Are you investing because you believe in the long term? Or are you here to make money on short-term trading?
The answer to these questions can help you make the right decision. In either case, you will act according to your goals. In other words, if you believe in the long-term possibility, think with that mindset. If you are here for a quick trade, think about that mindset.
- Assess the situation
Is there news driving the trading price of Bitcoin and other cryptocurrencies? It is possible that it is basic news that has changed the market’s sentiment, and it is not just price action or reputation-driving sentiment.
In 2021, actual development will affect prices. China’s move to ban financial institutions from offering crypto-related services was a further breakdown since the country had already banned cryptocurrencies in 2017, although it had not banned individuals from owning cryptocurrencies. As late as 2021, the Federal Reserve decided to reduce liquidity in the financial system, and many cryptocurrencies have been on a significant downturn well into 2022.
In May 2022, Stablecoin TerraUSD fell when traders engaged in an old-fashioned bank run, fearing it did not have cryptocurrencies to support the link to the dollar. This news spread to other crypto markets as traders worried that sales would lead to more sales.
So these moves have been further significant blows for the market, which had had significant capital inflows.
- Remember that Volatility is the name of the game
Cryptocurrency is volatile by nature. Because crypto does not generate any cash flow, traders must rely on changes in sentiment to drive the price. This means that the market can swing from rapid optimism, as it did in early 2021, to pessimistic despair, as it did a few months later. The news of the Coinbase IPO in 2021 helped drive positive sentiment for crypto, while the reduction in liquidity drove pessimism at the end of 2021 and the beginning of 2022.
So when you have an asset that is driven by sentiment, the emotions of traders drive the market. This is true of stocks as well, but they can also have a real flow of growing cash flows from the issuing company to accelerate them higher.
This volatility is exactly what attracts professional traders, who use powerful algorithms to make sophisticated trades, something that mom and pop traders usually do not have the advantage of using. Traders like volatility since it gives them a chance to make money – it’s Wall Street’s game.
- Consider the future
Analyze how the basic situation can play out for crypto, given new developments: Will governments get tougher on it? Will they encourage wider use of it? Will new regulations help rather than hinder the cryptocurrency market? What else can drive the market?
Is China’s move to ban crypto a herald of things to come? May be. India has practiced the idea of banning cryptocurrency, while the Russian central bank has also expressed opposition to it. But other countries, including the United States, are exploring how to regulate cryptocurrency instead of banning it directly. Some countries, such as El Salvador and the Central African Republic, have even made it a legal tender.
How other large countries are progressing remains to be seen, but it is clear that cryptocurrencies face real threats in the form of regulation, including regulation that can literally put them out of business. As crypto succeeds, it risks becoming a victim of its own success.
It does not help that crypto is used as part of ransomware attacks and other criminal activities.
Therefore, it is not excluded that the dreams of crypto are only legislated out of existence. Of course, the political implications are only one side of their future. Crypto faces other significant obstacles, including the economic and environmental costs of extracting them.
And finally, IRS taxation rules make crypto unmanageable as a payment system.
- Decide how to act
After you have finished cooling down and have assessed the situation and what it means for the future, you should consider how to act.
Are the risks really opportunities in disguise? If you see it this way, you may want to continue holding your position or use a fall in the price to invest more.
Is the risk likely to persist or even worsen? If so, you may want to take your losses now and stay out of the game for the future.
Is the situation too vague? If it’s hard to see the way forward, consider splitting the difference, selling some of your position today while still having potential upside tomorrow.
Cryptocurrencies are very volatile, and many investors do not feel comfortable investing a lot of money in them. The good news for investors is that they have alternatives to cryptocurrencies that offer attractive long-term returns:
Individual shares. If you are willing to do the analysis and continue to track the company, you can achieve very good returns by investing in individual stocks like Amazon or Apple.
Dividend shares. If you are looking for a cash payment as part of your investment, you can buy dividend shares. These tend to be less volatile than equities overall.
Index fund. If you do not want to do the job of finding individual stocks but still want a high return, 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 are looking for a healthy cash payout, REITs are another alternative to dividend stocks. REIT owns and operates real estate and has a good long-term overview of returns. You can even buy a fund, so you do not have to choose individual REITs.
These are some of the options with the highest potential for cryptocurrency. A plunge in the cryptocurrency markets can make you feel shaky. Use it as a wake-up call to reconsider why you are involved in the market, to begin with. What opportunities and risks does it provide?
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