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Crypto market: Why is there a crash and what’s next?

The plunge in the value of cryptocurrencies also revealed that they are not as insulated from the financial markets as they are made out to be.

May 13, 2022 / 01:47 PM IST

The cryptocurrency market has endured a face-ripping freefall over the past fortnight. Fear and panic gripped the market as Bitcoin, the world’s first digital currency, tanked below $30,000 twice in a week, its lowest level in 16 months. Other blue-chip cryptos fell, with losses ranging from 30 percent to 90 percent.

There was also a setback for the Terra Protocol and its ecosystem, which were supposed to maintain stability in the crypto market. The UST – the protocol’s algorithmic stablecoin – lost its peg and dropped to about $0.001. Amid the Terra Luna crash, Binance, one of the largest crypto exchanges, delisted the UST-linked $LUNA token. The cryptocurrency fell by over 99 percent.

Here’s a look at the reasons for the crash, whether this is a good time to buy, and what investors can expect from the markets in the future.

Reasons behind the crash

Inflation, the US Federal Reserve raising interest rates, and the war in Ukraine pumping up oil prices have all dampened market sentiment, which spread to crypto as well.

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Cryptocurrencies were presented as an asset class separate from the financial markets, untouched by the instabilities of the stock markets. However, the past two weeks have shown that cryptos are not insulated from the broader market sentiment. An estimated $200 billion of investor wealth was wiped out last week.

Strategy for those invested in crypto

For those invested in the crypto markets, there is no need to panic even though things may not look good now. This asset class has always been volatile and such crashes have happened before – in 2021 and in 2017 – and it has bounced back to all-time highs. Investors should hold on to their investments and focus on long-term goals.

Crypto, as an asset class has, over the years, has shown it can deliver good returns and the lesson from the recent crash is that diversity in crypto allocation is important. Focus on blue-chip coins, rethink strategy, and depending on risk appetite, maintain crypto holdings at 10-20 percent of the portfolio.

Why has Terra Luna crashed and what is the ‘de-pegging’ of TerraUSD (UST) stablecoin?

The crash of the Luna cryptocurrency has resulted in many lost fortunes. It was also a massive hit on crypto’s stability. The primary purpose of these stablecoins was to bring stability to the crypto markets. Speculation is rampant over why this happened, and Do Kwon, Terra’s CEO, is yet to come up with a formal explanation.

Luna is the token that powers Terra’s protocol. Its main use is to provide liquidity for trades and keep the price of UST stable. The problem is that as long as the price of UST is below its peg, it creates an arbitrage opportunity for users to burn UST and mint Luna.

Do Kwon has said they are working on a recovery plan, but there is nothing official at this time.

Is this the time to bottom-fish?

Whether the crypto slide continues remains to be seen. However, there are chances the bear market will continue as investors remain cautious about buying on dips. After Bitcoin dropped below $30,000, its price corrected further when evangelists “bought the dip” or entered the market at a discounted rate.

Amid its day-to-day turbulence, Bitcoin and other blue-chip cryptos are likely to continue the zoomed-out growth pattern displayed over the past decade. Instead of waiting for an absolute bottom to start buying tokens, investors should average out their costs in small quantities as prices decline and follow the same strategy as prices start rising. That should smoothen out the volatility and enhance returns. So buy low and HODL – Hold On for Dear Life – from a long-term perspective.

Disclaimer: The views expressed in this column are personal.



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Murtuza Merchant is a senior journalist and an avid follower of blockchain and cryptocurrencies.
first published: May 13, 2022 01:47 pm
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