Cryptocurrencies are notorious for being volatile, and the fact that their prices fluctuate wildly is really quite normal. However, what is not so normal is when the price suddenly plummets and wipes out a huge amount of value.
That is what is known as a crash, and it is one of the things that people fear most. Over the years, there have been several cryptocurrency crashes, and the most notable was in 2018 when the value of cryptocurrencies fell over 60% in about a month.
As unpredictable as these crashes are, they are not without cause. In fact, there are several factors that contribute to a cryptocurrency crashing, and if you know what they are, then you can take steps to be safe.
Significant Profit-Taking
The initial cause behind a cryptocurrency crash is often profit-taking. Profit-taking is simply the practice of selling after a cryptocurrency has gone through an increase in price, and on its own, it is a perfectly normal occurrence.
However, when there is too much profit-taking, it can create selling pressure—and that can lead to the start of a crash.
Knock-On Effect and Panic
If selling pressure starts to build up, it can drive other investors into selling their cryptocurrency too—and create a knock-on effect. When the effect is large enough, it can make many people panic, and result in a cascading sell-off.
Nowadays, panic can spread very quickly, and in a short period of time, a cryptocurrency could lose a huge chunk of its value. Once the knock-on effect starts, it is difficult to stop, unless investor confidence is restored quickly.
Break of Support
Another factor that contributes to a large-scale crash is when a cryptocurrency breaks past a particular level that was “supporting” it. For example, the cryptocurrency’s price may hover around the $1,000 mark for some time—but once it breaks past that and gets lower, it is likely to drop quickly.
Typically, when a cryptocurrency breaks through a support level, it does so with force and triggers a big crash in its value. The 2018 crash happened when Bitcoin broke through the $6,000 support level, and its value immediately dropped like a rock.
Bitcoin Reliance
For better or for worse, Bitcoin is the face of cryptocurrencies. As such, the value of all other cryptocurrencies relies on BTC to some degree and is influenced by its price when it is doing well and when it is doing badly.
When Bitcoin is trending normally, that reliance is not a big deal. However, if BTC does crash for any reason, it tends to drag down cryptocurrencies across the board, and most of them crash too.
Project Closure
In many cases, the crash of a cryptocurrency may not be due to market forces, but instead simply because the project itself is winding up and about to close. The majority of cryptocurrencies are essentially startups, and many do not survive more than a year or two.
Needless to say, when it is clear that the startup is going to shut down, the value of the cryptocurrency itself will plummet.
Knowing the factors that can make a cryptocurrency crash is useful regardless of whether you trade Bitcoin or some other token. Aside from taking steps to mitigate your risk, you may be able to identify the early warning signs of a possible crash—and quickly take steps to prevent too much damage.
Make no mistake, it is not possible to completely avoid the exposure from a cryptocurrency market crash. However, it is possible to limit your losses.
Featured image: DepositPhotos © KostyaKlimenko