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Why is crypto crashing now?

June 23, 2021, 10:00 AM UTC

Coinbase went public on April 14, 2021, to much fanfare and hype. It was seen as crypto’s acceptance into the mainstream. That same day Bitcoin reached an all-time high of roughly $64,000.

It’s been a bloodbath ever since then for both crypto and Coinbase. Though Coinbase shares soared to as much as $429 on the very same say the crypto exchange did a direct listing of its shares, from that first day sugar high, COIN’s shares are down nearly 50%.

Bitcoin has also been cut in half over the past two months, briefly falling below $30,000 Tuesday morning. Ethereum is more than 50% off its highs from early May. Many other crypto assets have fallen even further with a number of tokens down 70% to 90% in value.

If you’re new to investing in the crypto space or just interested now that prices have fallen substantially, there are a number of lessons we can take away from the current crash.

Crypto is extremely volatile

The daily price volatility for Bitcoin over the past three years is 75%. In comparison, the S&P 500 daily volatility over the past three years has been 22%. So Bitcoin has been roughly four times as volatile as the stock market.

But these numbers likely underestimate the actual volatility of Bitcoin considering crypto trades 24 hours a day, seven days a week. It’s much harder to sleep well at night as an investor when markets are always open, and potentially crashing.

For the uninitiated, this type of volatility can tempt you to trade more than you’re comfortable with because prices are constantly rising or falling much faster than they do on the stock market. The higher the market volatility, the higher the behavioral volatility.

Uncorrelated assets go in both directions

There are many reasons people hold crypto in their portfolios. Some people assume it acts as a hedge against central bank actions. Others look at it as an inflation hedge. Still others view crypto as an asset that can add diversification to a portfolio of traditional financial assets.

It’s important to remember correlation relationships in the markets are constantly changing. For example, during the onset of the pandemic, when the S&P 500 fell 34% in a matter of weeks, Bitcoin was also crashing, even falling 50% in a two-day period in March 2020.

Yet during the current crypto crash, the stock market has barely taken notice. The S&P 500 is up more than 13% on the year and has hit seven new all-time highs since Bitcoin peaked in mid-April. Stocks haven’t broken stride since crypto started to crack.

Sometimes a lack of correlation can be good, and sometimes it can be bad. This is the nature of diversification.

Crypto has idiosyncratic risks

There are a number of reasons crypto is crashing at the moment. Some point to China’s increased regulations. Then there is the on-again, off-again relationship with Tesla’s volatile CEO, Elon Musk.

There’s also a lot of leverage in this space, so losses can snowball once they get started. According to the Wall Street Journal, there is three times the amount of margin debt in crypto versus the stock market. And when margin calls hit in crypto, many of those positions are immediately liquidated, which can create a cascade of selling.

It’s also worth pointing out this is still an asset class in its infancy. The Bitcoin white paper was released in the summer of 2008. Although the gains have been astronomical since then, cryptocurrencies have their own unique set of risk characteristics.

The fact that there is a limited supply of Bitcoin creates an additional level of volatility because there are so many early adopters who simply buy and hold without ever selling. This means the small supply of Bitcoin that does trade can move the price in a bigger way. Volatility is baked into Bitcoin’s DNA. And unlike stocks and bonds, Bitcoin has no cash flow to speak of. It is part currency, part commodity, part innovative technology, and part human nature.

Add it all up, and the risks to this asset class are distinct. Those risks can add to both upside and downside volatility.

This is nothing new

Losses are nothing new to longtime crypto investors. Bitcoin fell more than 80% from 2013 to 2015 and again from 2017 to 2018. This is now the 10th time since 2017 that Bitcoin has fallen 30% or more from an all-time high. In that same time, the U.S. stock market has fallen 30% or more just once.

Despite these losses, Bitcoin is up 30x since the start of 2017.

Making money in any risk asset is not always easy. You must be willing to accept large losses occasionally over the short term to earn higher returns over the long term.

This is more true in crypto than in any other asset class. If you can’t handle wild price swings, crashes at all hours of the day, and bone-crushing volatility on occasion, you don’t have what it takes to invest in this asset class.

Ben Carlson is the director of institutional asset management at Ritholtz Wealth Management. He may own securities or assets discussed in his columns. As of June 2021 he was long Bitcoin and Ethereum in his portfolio.

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