Beginner’s Guide on Crypto Winter: How to Invest During Crisis?

If you are reading this, you have probably been affected by the crypto winter to a certain extent. The bear market has taken its toll on many investors, with some even giving up on their investments. However,  this does not mean that all is lost. And in the following guide, we will explain why.

Crypto Winter Defined

Crypto winter is a term used to describe the market conditions in the cryptocurrency industry. It is characterized by a prolonged bear market where prices of digital assets plummet, and investors lose confidence in the industry’s future.

The term was coined in 2018 when the crypto markets experienced their biggest crash. At that time, the prices of Bitcoin (BTC), Ethereum (ETH), and other major cryptocurrencies fell by over 80% from their all-time highs.

This caused immense financial losses for investors and businesses involved in the industry. Many projects had to shut down and lay off employees. The market capitalization of the entire industry fell from over $800 billion to less than $200 billion.

It is still unclear what caused the crash. Some believe it was due to market manipulation by big players, while others attribute it to regulatory uncertainty and the bursting of the ICO bubble.

Cycles In the Crypto Market

There are two main theories explaining and predicting the cycles that occur in the cryptocurrency market.

On one hand, there is a theory of the four-year cycle, also known as the “halving” or “reduction by a half” cycle. This cycle is directly related to the protocol of issuing new Bitcoins, which states that the miners’ reward for creating blocks is halved every 210,000 blocks, approximately every four years.

According to this theory, the reduction in the supply of new Bitcoins entering circulation every four years, along with stable or growing demand, causes an increase in the price of Bitcoin. This price increase pattern post-halving has been observed after the two previous halvings in 2012 and 2016.

On the other hand, we have the Elliot Wave theory that analyzes crypto market cycles based on the psychological and behavioral aspects of investors. This complex theory suggests that markets move in waves, each with a different psychological effect on participants.

According to proponents of this theory, studying these waves allows predicting turning points in bullish and bearish cycles. However, its complexity and subjectivity make not everyone trust its predictive utility.

It’s worth noting that during a bullish cycle, the prices of cryptocurrencies like Bitcoin and Ethereum increase dramatically and continuously for weeks or months. Then, a prolonged bearish cycle or “crypto winter” follows, where prices fall substantially and remain depressed for an extended period.

These cycles are largely due to the speculative nature still prevailing in the cryptocurrency market, as adoption is still in an early stage.

Reasons for Crypto Winter

There are a variety of reasons that cause a crypto winter, such as:

• Speculative bubbles. Cryptocurrency prices artificially inflate due to speculation and euphoria, reaching unsustainably high levels disconnected from real fundamentals. Eventually, these bubbles burst, leading to a sharp correction. For example, after Bitcoin’s price nearly touched $20,000 in late 2017, it sharply dropped in 2018, initiating a prolonged crypto winter.
• Stricter regulations. As cryptocurrencies gain greater adoption, financial regulators worldwide begin to establish tougher rules to control this market. This cools speculative interest and triggers capital outflows. A concrete case was the ban on cryptocurrency advertising imposed by Meta Platforms Inc (NASDAQ: META) and Google LLC after the 2017 bubble.
• Hacks and frauds. This has been one of the most significant reasons tarnishing the crypto industry’s reputation, due to the uncontrollable increase in serious security incidents and high-profile fraud cases. The most notable fraud case before FTX was the MtGox exchange hack in 2014, where thousands of Bitcoins were stolen.
• Technical issues. Despite the enthusiasm surrounding cryptocurrencies, many of these projects have numerous critical flaws, bugs, and other issues in their code that make it easier for hackers to carry out attacks. This negatively impacts the industry’s reputation.
• Macroeconomic news. The cryptocurrency market is not immune to external events, especially at the macroeconomic level. Recessionary environments, rampant inflation, and other bad macroeconomic news are the main reasons for bearish cycles. Investors tend to seek refuge in more stable assets like the dollar, triggering a massive sell-off of cryptos, as happened after the 2008 financial crisis and during the current inflation that has been haunting the US since 2022.
• Investor cycle shift. This refers to investors rotating capital towards new trending assets, such as artificial intelligence, a technology that, while not new, has become the trend of 2023, with companies like Nvidia Corporation (NASDAQ: NVDA) surpassing 180% growth during this year. In 2022, the crypto industry experienced a boom of investments in renewable energy and negative publicity from major investors like Elon Musk, who abandoned Bitcoin due to its energy consumption and environmental pollution. However, the University of Cambridge’s Centre for Alternative Finance (CCAF) demonstrated that BTC mining consumes much less energy than previously estimated, representing only 0.54% of global energy consumption.

Crypto Winter vs Bear Market

Although the terms “crypto winter” and “bear market” are often used interchangeably, there is an important difference between them.

For instance, a bear market is considered when cryptocurrency prices experience significant declines, typically a drop of more than 20% from previous highs. However, these declines occur during relatively short periods, lasting a few months. Bear markets are temporary corrections within longer-term bullish trends in the crypto market. For example, Bitcoin has gone through several bear markets of declines of 30% or 40% in recent years, yet the market favorite has managed to recover its price in a matter of months. These falls are considered normal given the market’s high volatility.

On the other hand, a crypto winter involves much deeper and sustained declines, with most cryptocurrencies losing more than 90% of their values. Therefore, the crypto winter, rather than a correction, is a shift to a bearish cycle.

During a crypto winter, prices remain depressed for an extended period, stretching for 12 months or even longer. This causes a drastic shift in market sentiment, leading many investors to refer to cryptocurrencies as speculative bubbles.

The last significant crypto winter occurred after Bitcoin’s historical peak in December 2017, which saw its price plummet by over 80%, lingering until early 2019 when a new bullish phase began.

Crypto Winter 2022

The crypto winter of 2022 began with a massive sell-off that wiped out billions of dollars in value, less than a year after the total market capitalization of the crypto market exceeded $3 trillion. 2021 marked the climax of an exceptional bullish cycle that spanned the entire year until December when market sentiment began to shift. Prices entered a corrective phase, deepening over the following months. By June 2022, Bitcoin was trading below $16,000, experiencing a drop of over 75% from its historical peak.

Among the primary factors catalyzing the onset of this crypto winter, the decision of the U.S. Federal Reserve to start raising interest rates in an unsuccessful attempt to control inflation stands out. This led to a capital rotation from speculative assets like cryptocurrencies to more stable investments.

Similarly, several significant crypto projects, such as Terra LUNA, collapsed in May 2022 due to “technical issues” with its algorithmic stablecoin TerraUSD, contributing to the collapse of multiple crypto investment funds heavily exposed to both LUNA and UST.

Notable companies that collapsed in 2022 because of Terra LUNA include Celsius Network, which froze withdrawals and transfers from its lending platform in June 2022 and declared bankruptcy in July 2022, Voyager Digital, which declared bankruptcy in July 2022, and Three Arrows Capital, a major cryptocurrency hedge fund that defaulted on credit in June 2022 and later declared bankruptcy.

Additionally, the largest scam in the US was perpetrated by the young prodigy Sam Bankman-Fried, who was eventually found guilty of embezzling billions of dollars from his clients through the cryptocurrency exchange FTX, declared bankrupt in early November 2022.

FTX had become one of the world’s largest cryptocurrency exchange platforms, valued at over $32 billion in early 2022. However, due to concerns about its financial solvency following a Bloomberg article and a tweet from Changpeng Zhao, CEO of Binance, announcing the sale of all his FTX tokens, a massive user run trying to withdraw their funds from the platform occurred, leading to the collapse of the exchange, which truly had no way to reimburse that money as it had been misappropriated.

The fall of LUNA, combined with FTX, buried the prices of many cryptocurrencies, prolonging the bearish cycle or crypto winter, with drops from historical highs exceeding 90% in major digital assets.

Moving Into 2023

Crypto winter continued in 2023, extending the bearish trend that started in mid-2022. The initial months of 2023 have been marked by a number of the following events:

• A wave of layoffs in crypto companies. Dozens of companies in the crypto ecosystem, including the largest exchanges in the market such as Coinbase Inc (NYSE: COIN), Kraken, and Crypto.com, found themselves needing to lay off a significant portion of their staff to survive the crypto downturn. More than 25,000 layoffs related to crypto industry companies are estimated.
• Lower activity and investor interest. Cryptocurrency trading volumes and related searches remained well below the peak of 2021 and even 2022. The valuation of companies like Coinbase dropped by up to 80% compared to their historical highs.
• Increased regulatory scrutiny. As said above, the fall of FTX and Terra LUNA attracted greater global attention from regulators regarding deceptive practices and risk management in the crypto industry, especially in the US, where cryptocurrencies became a daily topic in Congress, with some politicians proposing bans and stricter rules for sector companies.
• Teetering crypto projects. The vast majority of blockchain projects that raised millions in funding during the 2021 boom faced significant financial difficulties in 2023 to continue operating. However, the rise of BTC has helped many of them stay afloat.

It is worth mentioning that in November 2023 the enthusiasm in the crypto market among institutional investors renewed, due to the possible approval of a Bitcoin Exchange-Traded Fund (ETF) by the US Securities and Exchange Commission (SEC).

This follows BlackRock, one of the world’s largest asset managers, showing interest in Bitcoin and requesting an ETF directly based on the cryptocurrency from the SEC. This milestone has propelled the price of Bitcoin from $27,000 to over $36,000, bringing optimism to the industry.

Investing During Crisis

Investing during prolonged bear markets requires specific strategies to cope with high volatility and low market returns. Some tips for surviving and investing in these crisis times are:

• Focus on solid projects. Instead of seeking quick gains, it’s better to identify projects with real fundamentals, innovative technology, and experienced teams. These types of projects are more likely to recover after the bearish cycle.
• Take advantage of the fall to buy. Quality assets often fall to attractive prices during crypto winters, creating opportunities to buy cheap and increase positions for the recovery. However, as with any investment, risk management is crucial to avoid investing more than you can afford to lose.
• Look for countercyclical investments. There are opportunities in sectors less correlated with cryptocurrencies, such as renewable energy, real estate, and commodities, among others. This can help diversify your portfolio and not be anxious or scared as the crypto market collapses.
• Focus on projects with real utility. While we have nothing against purely speculative meme coins, it’s best to choose tokens associated with blockchains with practical applications for the real world, such as smart contracts or decentralized finance. Even if they fall a lot, you can sleep soundly knowing that they will eventually recover without losing sleep over famous Shiba Inu breed dogs.
• Maintain a long-term perspective. If you’re interested in the cryptocurrency market, understand that crises pass and cycles change, and those who hold onto their investments in the long term have a better chance of recovering their losses and gaining in the future. Therefore, it’s best not to be swayed by panic, research as much as you can before investing in a project, and don’t spend hours staring at its price chart.
• Control risk. As mentioned earlier, in this market, it’s best not to overexpose or leverage excessively. Limit investments to a prudent percentage and keep cash reserves to take advantage of downturns. While it’s impossible to know when an asset is hitting bottom, it never hurts to make staggered purchases to increase your positions.

With patience, research, and a long-term vision, it’s possible to invest intelligently even in the worst and wildest of crypto winters.

Conclusion

While crypto winters present challenges for everyone in the crypto industry, they also offer opportunities for those with a well-founded, long-term vision. Overcoming crises demands patience, research, and risk control.

Hopefully, this guide has helped you comprehend and navigate both the current crypto winter and potential ones in the future.