Written by Jonny FryWriters linkdin: https://www.linkedin.com/in/jonnyfry/
Since the end of March, the price of Bitcoin has been slowly dropping. In May, however, the situation became worse; Bitcoin dropped further than it had in the preceding month, immediately causing the catastrophic failure of Terra, a cryptocurrency project which was once valued at more than $50bn.
This week, Bitcoin fell below $21,000 for the first time in over 12 months. The cryptocurrency is down more than 68% from its all-time high, close to $68,990, back in November 2021. Likewise, Ethereum is down 63% from the historic highs set in the same month. In both cases, over 50% of the decline occurred this year. Experts have warned that things could continue to deteriorate, although the current situation doesn’t yet match the severity of the 2018 crash (in which Bitcoin lost 80% of its value). Nonetheless, investors are at a crossroads. Many, following the old investment adage ‘buy the dip’, are looking for a piece of the volatile crypto market in the hope that this is a temporary downturn rather than a long-term bear market. Furthermore, some investors, in a bid to be careful, have asked the critical question: “Should I buy the dip?"
Is it time to buy the dip?
So, back in November 2021, Bitcoin was trading at around $69,000 but, suddenly, it slipped to around $55,000. It was called 'dip' and, unsurprisingly, many investors jumped to 'buy the dip'. A month or so later and Bitcoin fell to around $45,000. Here was another chance to buy the dip, and many investors took that chance. Again it dipped, this time to around $33,000, and once again the hopefuls bought the dip. Currently, Bitcoin is trading at around $23,000. The principle of buying the dip is based on an assumption that these price drops are temporary aberrations, correcting themselves over time. The buyers hope to exploit these dips by buying at a relative discount and reaping the rewards when prices rise again. It has happened many times before and it can happen again. However, cryptocurrency markets are notoriously volatile; hence buying crypto at any price - dip or no dip - is risky. Although prices could return to previous levels, on the other hand, they could leave your investment underwater by falling even further.
Total market cap: from over $3trillion to $1trillion
Source: Coingecko
If the past is prologue, then the current crypto crash could bounce back as it did last year when prices fell to similar levels before returning to pre-dip levels. But of course, there is a possibility that they might not. Worthy of note is, that every kind of investment has past performance which is no guarantee of future results. Whether or not to buy the dip cannot be answered in one word. You may have to ask yourself questions before taking either step. What amount of money can I afford to lose, since any investment has its inherent risk? How long am I prepared to wait if the price does not rebound in the short term? Do I set a stop loss - i.e. if the price falls by another 25%, do I stay invested or leave an order with an exchange to sell?
Why is crypto crashing?
The specific reason for the current dip is yet to be agreed on. There are, however, speculations. The decline has been attributed to comments made by Bill Gates on Reddit, whereby he shared his thoughts and displeasure about how the value of crypto is based on what one person decides. Tesla also made a U-turn on accepting Bitcoin as payment for its products. China, in the latest wave of restrictions on cryptocurrencies, ordered Bitcoin mining in its Sichuan province to shut down completely and told banks to stop supporting crypto transactions. All these are thought to have had an impact on the global crypto market. The crypto crash has also been linked to a massive sell-off by investors amid heightened inflation fears, the crash of Terra stablecoin and the pausing of withdrawals by the crypto-lending service, Celsius. Investors are also staying away from riskier assets, consequently being reflected in the stock markets as well.
Crypto price correlation with tech stocks
One of the limitations of Bitcoin is its dependence on economic policies that so often cause ups and downs in equities. In the current market state of rising interest rates and increased inflation, most assets have been hit hard, Bitcoin included. Amid this downturn, questions have been raised as to whether Bitcoin is correlated or uncorrelated to stocks. According to CoinDesk, for most of 2021 Bitcoin remained within a range of -0.2 to 0.2 when compared to the S&P 500, gold, the U.S. dollar and bonds. This value indicates that Bitcoin is were largely uncorrelated to other assets. Blockchain Center, which monitors cryptocurrency price movements, has conducted further research which proves that Bitcoin was uncorrelated to the S&P 500 even further back, for a stretch of nearly two years from 2019 to 2021. However, times have changed and market conditions are becoming less focused on growth. Both the CoinDesk report and data from Blockchain Center reveal that Bitcoin initially became correlated to the S&P 500 in the last quarter of 2021. The 90-day correlation between S&P 500, gold, the U.S. dollar and bonds increased with Bitcoin from 0.2 (no significant correlation) to about 0.6 (fairly strong correlation).
What to do?
Experts suggest refraining from buying large amounts of cryptocurrency at any one time when investing. A price drop after investing large amounts could be catastrophic. Whether the price goes up or down, it is advised to buy a small amount every month (pound cost averaging) as opposed to investing 100% at once.
Considering the volatility of crypto, it is way too much risk to make cryptocurrency your only investment and having exposure to other asset classes such as equities, bonds, real estate, etc, can all help to create a more diversified portfolio. It is essential to do your research, buy a selection of cryptos (as there are thousands to choose from) or consider a fund that invests in a range of cryptos and is professionally managed. This helps to spread your risk; if one falls in value, others may not. In rare cases, most of them may go down. This only shows how unpredictable the cryptocurrency market can be. The crypto markets are relatively illiquid and so a relatively small amount of capital can make prices rise as well as fall. There are now more people and institutions engaged with cryptos so liquidity is improving, but the volatility of crypto prices is likely to remain for a while. Knowing when to buy and sell is often a matter of luck, not judgement, as sentiment often tends to be the biggest driver of prices and sentiment, by its very nature, is a ‘tad’ fickle!