Cryptocurrencies during crises. How do crypto assets work in turbulent times?

Currently, the entire crypto industry is suffering from a crisis, the emergence of which was influenced by many factors, from the collapse of the LUNA cryptocurrency and the UST stablecoin to the new regulatory policy of the US Federal Reserve System. And although this is not the first steep peak for cryptocurrencies in their short history, each "crypto winter" makes investors, traders, and all those interested in the development of crypto assets think about the reasons for their fall.

Together with the co-founder and CEO of the Ukrainian crypto community, Crypto Crew, Vadym Korolenko, we answer the most common questions about cryptocurrencies in crisis situations.

How do economic crises affect crypto assets?

Any global economic crisis affects all financial markets. Usually, smaller markets repeat the trends of larger ones. So the same thing is happening with cryptocurrencies and digital assets as with larger markets.

Let's look at the stock market, which is currently declining. A small, in terms of capitalization, market of crypto assets will follow this trend. This is what happened during the COVID-19 pandemic: at the end of February 2020, there was a sharp decline in the "barometers of the American economy" and such indices of world stock exchanges as Dow Jones, Nikkei, and FTSE. Following the decline of stocks, the cryptocurrency market also collapsed.

Stock markets have been actively declining since December 2021. For some time, cryptocurrencies were still at a high, but then went down with the same trajectory. Then there was a bear market.

There is a very apt saying among traders: "Stairs up, elevator down." Now we are still flying down this elevator and will continue to do so until all the shorts are out of their positions. And then there will be a rise again.

The 2020 crisis collapsed stock markets, but at the end of the year there was a massive rise in digital assets. Why was there growth then, and now the opposite?

No one was prepared nor expected a covid fall. The US Federal Reserve System reacted by simply printing a lot of money. People began to buy and use this currency – so it moved to other markets, including crypto assets. As a result a bubble was created, and all that money influenced the growth of cryptocurrencies.

What happened to LUNA and UST?

In April 2022, the LUNA coin was among the top 10 largest cryptocurrencies by capitalization, and as of today, it has dropped out of the top 50. This cryptocurrency provided the assets of the Terra blockchain platform, designed to issue algorithmic stablecoins. In May, it lost 99% of its value. This was preceded by the withdrawal of 30,000 BTC from the Terra USD (UST) stablecoin by an unknown investor. Then it turned out that UST was no longer backed by anything.

It would be fair to assume that this was probably a scam. There are rumors that it was a long-planned attack, which could have been backed by large market players – for example, institutions that represent the interests of the banking sector and work against crypto. Another allegation is that smaller players chose a victim asset, filled it with funds for a long time, affecting growth, and then began to sell everything. Thus, liquidity goes to those who made investments at small values of this coin.

This situation also affected the value of bitcoin. Its price has fallen by more than 50% from its peak in November 2021 and is now $16,800 as of the moment this article is written. Crypto investors' faith in stablecoins – and cryptocurrencies in general – has been undermined. Nevertheless, the Luna Foundation can still cope with the crisis in the long run.

How can cryptocurrencies help in situations where it is not possible to use fiat?

Cryptocurrencies are digital assets, which means they only exist virtually. Crypto owners store it in a digital wallet and make online transfers only. This money becomes a good alternative to cash payments in terms of convenience and speed.

There are cases when you need to urgently transfer a large amount of money, and losing a good share of it due to bank fees is not a very attractive option. In this case, fiat money is significantly inferior because the transfer of cryptocurrency takes minutes, the commission is several times less than the bank's, and for P2P transactions there is no commission at all.

How can digital assets help the country in times of crisis?

There are cases in global practice where banks start lending against cryptocurrencies, in particular bitcoins. After all, bitcoin will grow one way or another. The fact that it can lose up to 90% of its value does not mean that it will ultimately lose all value and stagnate. If you look at its evolution, bitcoin has already gone from costing $1,000 to $5,000 between 2012 and 2016. A price drop of up to 90% would put it around $8,000 now. This trend indicates that despite its volatility, this asset will grow.

Can state regulation of digital assets be a way to stabilize them?

The policy that different countries choose regarding cryptocurrencies affects their growth graph for a short period of time. But in most cases, big news is a real catalyst for a fall or rise, not a trigger. For example, when El Salvador recognized bitcoin as an official currency in 2021, the price of the cryptocurrency started to increase, and when China banned any operations with cryptocurrencies, there was a sharp drop. However, after such cases, there is a correction, and the rate stabilizes again.

Regulation will not reduce the volatility of cryptocurrencies because no one is going to peg them to gold yet. However, gradual regulation – first, granting legal status and creating opportunities for crypto investors to declare their profits, and only then financial monitoring of virtual assets – will help not to scare people away and make the regulatory process as comfortable as possible for everyone. Cryptocurrency legalization and state recognition are also positive signals for investors.

Should you convert your fiat assets to digital currency during a crisis?

Diversification is the key when it comes to storing money. It is important to keep your funds in fiat, digital assets, and stablecoins. Providing that you have a strong faith in the stability of the dollar won't be the best option. It can be compared to business: any business needs a lot of options and diversification to withstand a crisis.

Should you reconsider your trading strategy during the crisis?

Investments can be short-term or long-term. Those investors who have long-term investments are less affected by crises. Such a strategy involves setting a certain margin threshold before which the investor does not touch his investments.

We advise you to look toward the most stable coins and those that have been on the market for the longest time: bitcoin and ether. Pay attention to coins with real technology behind them, such as the BNB. Diversify your portfolio so that 60% of it will be stable and older coins. Why do we recommend not investing most of your funds in alternative crypto? There is an opinion that with the fall of large coins, up to 80% of altcoins may simply disappear. This conclusion can be drawn from previous cryptocurrencies and the sad fate of some altcoins, such as Litecoin, Ripple, and Dash.

Finally, it will not be superfluous to mention the scandalous FTX case. It would seem that the fourth largest crypto exchange in the world, with thousands of investors, and Bankman-Fried's reputation as a young billionaire who changes the market, could not be the worst place to put money. However, only four days passed from the assurance of the FTX founder that "everything is fine" to the announcement of his resignation and bankruptcy filing. What does this indicate? Despite the stability of the coin, a large number of users, the fame of the founder, and a kind of "closeness" with users, it is worth considering the risk of unforeseen situations and always taking into account important factors that seem to be little talked about.

Author Bio

Vadym Korolenko is CEO of Crypto Crew which is the fast-growing Ukrainian educational community on crypto. The team’s main goal is to explain to users that cryptocurrencies are not about “easy and fast money”, but about knowledge, skills, and abilities. The Crypto Crew's community already has more than 3500 members.