4 Reasons Why Bitcoin Crashes

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They say stocks are volatile. Markets can swing so, if you’re invested, even with a boring 401(k), you have to be careful.

News headlines back this up. If you flip on Bloomberg or CNBC right now, you might see something like…

DOW DROPS 300 POINTS

…on the ticker. The Dow Jones Industrial Average is a grouping of 30 of the largest companies in America, so when it drops hundreds of points people take notice. Except, of course, the Dow is worth tens of thousands of “points”–34,000 as of this writing. So 300 represents less than 1% of the total.

So, really, stocks aren’t so volatile (most of the time). T.V. channels just need new content to feed the 24-hour news cycle.

You know what’s actually volatile?

Cryptocurrencies.

When Bitcoin falls 0.6%, it doesn’t make the news. Nobody bothers to tweet about it or, really, give it a single fleeting thought. Because Bitcoin–and, even more so, smaller cryptocurrencies–is usually fluctuating at a much greater scale than that. In fact, outright crashes are a rather regular occurrence. The kinds of drops that, in stocks, would tear down the entire global economy, in Bitcoin, happen almost too often to care.

In the first half of this year, for example, Bitcoin didn’t just crash. It crashed every month.

From January 9th to the 12th, the price of one Bitcoin fell from over $40,000 to about $34,000. It recovered in just a couple of days, only to plummet again, from $39,000 to $30,800.

It hardly mattered, as Bitcoin proceeded to go on a tear. By February 21st it was at $57,000–nearly double, in only a month’s time. Then, by the end of that week of the 21st, it was back down to $45,000.

In March and April the same thing happened, almost like clockwork. First it was a 10% crash, then 20%.

Finally, from May 9th to the 23rd, Bitcoin fell from $58,000 to under $35,000. It stayed down there for a while, until it didn’t.

(image captured from Coindesk)

These are the kinds of crashes you only see once in a generation in the stock market. When COVID-19 first hit in March, 2020, the market crashed by about 30%. The Dot Com Bubble, from peak to trough, caused around 40% losses. The 2008 Financial Crisis: 50%. Those were major historical events we’ll read about in future textbooks. Bitcoin, meanwhile, dropped 40% in a couple of weeks because of a bit of news in China and some tweets from a Saturday Night Live host.

And it’s important to note: the first half of 2021 was not a recession but, quite oppositely, a period of immense growth for Bitcoin. Its price multiplied by over 600% since the previous Fall, and, in the period we’re discussing, hit all-time highs many times over.

In other words, major monthly crashing is what Bitcoin does when things are going well!

But why is that? Why is crypto so volatile? Why does Bitcoin insist on having a catastrophe every few weeks, even when there’s seemingly no cause? Here are just a few reasons to consider:

1. Markets naturally cycle between highs and lows

No matter what kind of market you’re looking at: cryptocurrencies, private equities, or secondhand Beanie Babies, you’re going to find cycles of highs, lows and stagnation. It’s only natural. Perhaps if buyers and sellers were robots, everything would be at its most accurate price all the time. But the world changes, buyers and sellers are imperfect humans, and so you get those waves.

Corporate stocks, for example, follow the business (or economic) cycle. In a somewhat reliable and repeating fashion, stocks tend to move through four phases–as described by the famous investor John Templeton: pessimism, skepticism, optimism, euphoria, and then back again. These stages are driven by changes in fiscal policy by central banks, profitability in businesses, and the irrational behaviors of consumers, businesses and investors alike.

In Bitcoin, rather than a business cycle, we have halving cycles. Every four years or so, the block reward–the amount of Bitcoin “miners” get paid for maintaining the network for everyone else–gets cut in half. What’s happened in the past, almost every time, is a reliable pattern of euphoria, followed by pessimism, then skepticism.

Why? The theory goes that when there’s less Bitcoin being created, and then distributed to miners, and the overall supply of Bitcoin decelerates, the value of existing Bitcoin goes up. There’s also a knock-on effect. Prior to halvings, some investors worry that the lesser rewards will disincentivize miners, and the network will become less robust as a result of fewer individuals and businesses dedicating themselves to its maintenance. When that doesn’t happen (it never does), investors who were shy about buying in the months prior suddenly feel free to buy, buy, and buy more.

(image via Bitcoin Magazine)

2. Major movements in other cryptocurrencies trickle up to Bitcoin

Bitcoin’s worst ever crash occurred at the beginning of 2018. In one month alone–from January 6th to February 6th–its price fell by two thirds. And the rest of the year brought no recovery. BTC ended 2018 down to around one fifth of its previous highs.

There were all kinds of reasons why this happened. But, arguably, the single greatest cause of Bitcoin’s crash had nothing to do with Bitcoin itself.

Leading up to the crash, cryptocurrencies in general were developing a…reputation. Off the success of Bitcoin and other coins–“altcoins”–lots of different kinds of people began to take an interest. The low barrier to entry in creating new coins, lack of regulations and high potential reward created a concoction, the result of which was hundreds of “initial coin offerings,” or “ICOs” for short. The problem? Around four of every five of them were outright scams.

None of those ICOs changed anything about Bitcoin itself. Still, as the industry as a whole became overrun by scammers, outside observers began to worry that all cryptocurrencies–Bitcoin included–were dangerous. Governments considered new regulations, and fewer people wanted to buy crypto. All those scams fell apart, and Bitcoin was pulled down with them.

The 2018 crash was a unique event, but it’s possible that future bubbles in the cryptocurrency industry will affect Bitcoin similarly. For example, while it’s not a neat parallel, the bubble in NFTs this past year shares certain similarities with ICOs in 2017-18.

3. Bitcoin is sensitive to the news cycle

Even rumors can send Bitcoin’s price tumbling.

On January 11th and 12th, 2018, Bitcoin was enjoying very high prices–$11,000, $15,000 and so on, as compared with $1,000 or lower before the bull run–but it was in flux. So, when news spread that South Korea might ban cryptocurrency trading, the price of BTC reacted: 12% down, in a matter of hours.

The same kind of thing happens today. As Bitcoin reached new highs in 2021, the government of China began threatening and, in some cases, implementing bans on cryptocurrency-related activities. It helped precipitate the fall that we still haven’t yet recovered from.

Perhaps the best example of Bitcoin’s sensitivity to news is how it reacts to every little statement or decision made by Tesla CEO Elon Musk. It’s hard to believe, but even a single tweet of his can cause the market to spike or crash. Famously, on May 12th, he tweeted that his company would reverse its policy on accepting Bitcoin as a form of payment, due to its environmental impacts. Bitcoin proceeded to fall by 15%. It hasn’t recovered since.

(image via CoinTelegraph)

4. Bitcoin is a speculative asset

The value of a corporate ownership share is determined, for the most part, by how stable and profitable the company is. The value of oil is determined by what’s happening in the economy, in supply chains and drilling. The value of artwork is rather illogical but, at its core, it derives from the beauty and uniqueness of the work.

Exactly where Bitcoin derives its value is somewhat less clear.

Originally, Bitcoin was created to allow individuals to pay one another without having to go through a financial institution. The problem is that almost nobody actually does that. People buy Bitcoin, but they don’t pay with it. (In very few countries, where inflation is rampant, Bitcoin has been used as a means of payment. But, even in those cases, “stablecoins” pegged to fiat currencies provide greater utility.)

In essence, Bitcoin has no use. It has no underlying value to fall back on, either–like a company or even an artwork would–because it’s just computer code. So people don’t buy it for its value, but for its price–because they think its price will continue to rise, because they think other people will be willing to pay more for it in the future.

We call assets like this speculative. Speculative assets are volatile by nature, because they rely on beliefs and predictions rather than underlying value. And humans are known for their irrational predictions and misguided beliefs.

Just think of any given year in Bitcoin’s history: 2016, 2019, whatever. If investors then could have known that Bitcoin would one day cost $60,000 apiece, they would’ve bought as much of it as possible. They couldn’t have known it, though, because Bitcoin is only worth what everybody thinks it’s worth at any given time. And in 2016–with prices below $1,000–the notion of $60,000 within 5 years would’ve seemed unattainable to most people.

It’s a problem we face in equal measure today. Bitcoin could cost $1,000,000 in 2026, or $100. It’s impossible to tell. Bitcoin will still be Bitcoin in 2026–nothing about it will have actually changed–but how people feel about it may ebb and flow wildly.

A motto you’ll hear a lot around cryptocurrencies is: “buy the dip.” The idea is that, when everyone else is selling, you buy, so that you can accrue more Bitcoin for yourself at temporarily depreciated prices. But knowing when the price has neared a bottom, and having the discipline to buy when things aren’t looking good, are very difficult. And, unless you’re a day trader, they’re beside the point.

What matters much more than any dip in price is the nature of what caused it–whether it was precipitated by:

  • A correction
  • A reactionary event, or
  • A structural bear market

Temporary market corrections happen all the time. The price of an asset goes way up, so savvy traders take profits and investors have second thoughts about the near future. Price falls to a more reasonable level, and then life goes on. This kind of thing is nothing to worry about.

If Bitcoin reacts to a particular news item, it may or may not be a sign of things to come. For example, if a major country introduces legislation to regulate the cryptocurrency industry within their borders, Bitcoin’s price could fall. But that could happen regardless of whether such legislation actually ends up going into effect. Often, in the past decade, countries have proposed regulations that ended up petering out. Then everything returns to normal.

The only major concern for Bitcoin “hodlers” is the prospect of significant, structural bear markets. Downtrends that occur for good reason, and leave an impact that lasts for a long period of time thereafter. As occurred in 2018. Such events are difficult to anticipate–especially in Bitcoin, which is an asset without underlying value to measure–but leave scars with anyone who lives through them.

Even if you end up on the wrong side of a major bear market, though, just remember one thing:

Almost every time Bitcoin has ever crashed–no matter the reason or degree–it has recovered.

The price of Bitcoin reached an all-time high this year. That means that, no matter when you purchased Bitcoin prior to 2021, if you held onto it, you ended up making money. It’s worth emphasizing this point, so let’s make it extra clear:

Imagine every crash Bitcoin has ever experienced, from 2009 through 2020. Imagine you bought Bitcoin only at the peaks of each crash. The day before each downturn. Each time you invested, you immediately lost money the next day. Seems like a nightmare, right? Well, as long as you never sold any of your holdings, by 2020, you would have ended up making a profit. And not just a profit, a massive profit, because every market peak from 2009 to 2020 was tiny compared with the 2021 all-time high.

There’s no guarantee that Bitcoin will continue its upward trajectory forever. But, if history is any indicator, you probably shouldn’t be worried about a crash here or there. In fact, the best thing for your wallet might be to shut off the news.

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