InvestmentPersonal Finance

Crypto Volatility – And How to Protect Against It

Over the last few weeks the cryptocurrency market has seesawed wildly with cryptocurrencies like bitcoin ranging from X to Y. That has mean investors have literally seen their crypto portfolios move by 50-100% in a matter of days.

So what’s causing all this movement – and should investors be concerned? And what can you do to protect against potential downside risk?

Let’s dive in!

Why the current volatility?

Crypto experts have generally identified 4 key factors that lie behind the recent volatility. Let’s take each in turn.

China

China’s State Council, the country’s central government body, said it would be “cracking down on bitcoin mining and trading activities” in an effort to prevent financial risks.

With a significant percentage of the world’s mining activities taking place in China, a lot of volatility can be caused by the crypto scene in China. This announcement by the Chinese government led to a huge sell off in the local crypto market.

China also banned financial institutions from providing crypto-related services and warned investors against speculation in the crypto market. This, no doubt, compounded the sell off and increased fear of further crackdowns in the market.

President Xi Jingping also said that China would be stepping up efforts to achieve carbon neutrality. With raging discussions taking place on the environmental impact of bitcoin mining, expect green policies to target miners – and again some downward price pressure as a result.

So all in all, this is definitely not the last we have heard from China on cryptocurrency and we would expect further market-moving developments to come about in the coming weeks and months.

 

USA: tax and regulation

The USA also made some not-so-unexpected announcements.

President Biden discussed giving the IRS additional funding to track crypto transactions. He also proposed the ratification of rules that would make it mandatory for businesses to report any crypto transactions above $10,000, something that already exists for cash transactions.

In addition to the Bank of England and HM Treasury jointly launching a task force to explore the potential of a Central Bank Digital Currency (CBDC), the Federal Reserve announced they would be releasing a paper this summer to try and explore the same thing

The crypto world keeps a very close eye on how governments of the world manoeuvre the regulatory landscape when it comes to cryptocurrencies. Any proposal to tax or regulate typically brings turbulence into your crypto portfolio.

Discussions around CBDCs are also important to watch out for. The exploration and potential launch of a CBDC would inevitably bring with it some form of regulation over the crypto space, causing further volatility and fear.

 

Elon Musk and the environment

Elon Musk is notorious for his market-moving tweets.

After tweeting about how Tesla will not be accepting Bitcoin anymore due to environmental concerns, the market crashed.

Musk’s tweet was significant for two reasons.

Firstly, it shone a brighter spotlight on the environmental impact of Bitcoin mining and has catapulted the conversation into the mainstream.

Secondly, it’s probably disincentivised some other companies from holding a portion of their balance sheets in Bitcoin or from accepting it as a form of payment.

When one of the world’s richest men and most famous business moguls tweets against Bitcoin, you can expect it to tumble. When this is Elon Musk – who has a long track record of moving markets with his tweets – you should run for the hills.

Musk is also backing the meme-currency Dogecoin and hailing it as the cryptocurrency ‘for the people’.

 

Inflation and interest rates

The broader market is experiencing jitters after inflation has started to creep up after a year of lockdowns.

Rising inflation brings with it the expectation of increasing interest rates.

Interest rates in an economy act as a brake since it becomes more costly to borrow money and so it slows down the velocity of the money passing through an economy.

Rising interest rates ripple across the economy, causing buyers to demand higher returns across all asset classes.

Investors across the world will be keeping a close eye on inflation fears in the coming months and years to strategise exits out of their positions.

 

What can crypto investors do?

There is only so much you can do to protect against the crazy volatility that an asset class like cryptocurrency experiences. Having said that, there are 3 key things you can still do to mitigate some of the impact.

Only invest in protocols you really believe in

There are an increasing number of cryptocurrencies available to buy.

Different coins and protocols are appearing every day purporting to be the next Bitcoin or the next meme-coin.

Beware of most of the coins being pumped by influencers and celebrities. Not only do a lot of influencers get paid to pump a certain coin, but something being pumped up continuously is a good sign that it’s probably a pump and dump scheme.

So the first lesson amidst all this volatility is to really do your research, read the white papers and study the underlying protocol and its real world uses. Don’t risk your capital based on herd mentality.

Sure, when there is volatility it will affect all protocols, but long-term, the ones with actual substance behind them are likely to fare better.

Remember, for some people to get rich quick, a lot of people also have to lose a lot of money.

 

Keep your crypto exposure relatively low

Since crypto is a very young asset class, it has not been tried and tested and we don’t know how it fares under different conditions.

A worthwhile strategy might be to keep your total crypto exposure low so that even if you were to lose a lot of your money, it wouldn’t affect your life.

Low exposure would also help you sleep at night since any volatility doesn’t significantly impact your overall portfolio.

You have to realistically assess how much money you can afford to lose in the market (this is a good mental tool for all investments!), then take a small percentage of that amount and put it towards a high-risk asset like crypto.

The majority of your invested money should be in safer asset classes generating steady and compounding returns.

 

Diversify

As regular readers of IFG will know, you should diversify your investments so that you’re not too concentrated and dependent on one single investment doing well.

The safety of diversification is putting your eggs in multiple baskets. If one basket gets lost, you still have the others.

You should diversify within your crypto portfolio – i.e. you should hold multiple cryptocurrencies rather than just pinning your hopes on one. You should also diversify across your overall portfolio by holding a range of different investment classes.

It’s also worth noting generally that it pays to have non-correlated asset classes, such as gold, that don’t move (or move inversely) when another asset classes in your portfolio face turbulence.

 

For more info on specific cryptocurrencies, check out IFG’s unique Halal crypto list.

You should also check out the IFG Crypto Guide.

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