In the second week of May, cryptocurrency enthusiasts around the world stared at their screens in awe as the market crashed before their eyes.
Coupled with the widespread economic uncertainty that began in the final weeks of 2021, crypto values were in any case on a general downward trajectory. But their decline turned into a collapse that reminds some traders of the beginning of the global financial crisis at the end of 2007.
The immediate cause was the terra implosion – the so-called stable coin, designed to reduce volatility in the crypto market by maintaining a constant value over time. However, unlike other stablecoins, Terra is not pegged to a stable reserve such as gold or the dollar. Instead, its stability relied on algorithms linked to its sister cryptocurrency Luna. As Luna’s price dropped from about $80 (£66) to a penny earlier in the month, Tera followed suit.
Their failure sent shockwaves through the market. The price of Bitcoin dropped to $26,000 in 2018. It is down 60% from its peak in November 2021, and Ether, the next largest cryptocurrency, has lost 30% in value. Coinbase, one of the largest cryptocurrency exchanges, reported a loss of $430m in Q1.
Although the market has stabilized somewhat since the end of May, the valuations of many cryptocurrencies are still very off. Some key financial institutions, such as the International Monetary Fund, have cited the recent collapse as evidence—if more needed—of the volatile nature of this asset class.
Individual traders bear the burden
There is an argument that the situation was worse for individual traders than for large investors. Aidan Mott, managing director of Intel at crypto research provider Messari, agrees, noting that this type of volatility has often led to strong rebounds for some currencies, particularly Bitcoin and Ether.
He says it has affected retailers more than large financial institutions. “Most people don’t have access to the large liquidity pools or other financial vehicles that the larger institutions that use Coinbase or Robinhood do. The high volatility for bitcoin and ether has led to price increases, which is good for institutional traders. If you have an asset with zero volatility, there is no chance of making a profit. It doesn’t make sense as an investment.
But choosing the right trading strategy for crypto is easier said than done. Consistency and quantification are at the heart of any successful approach. But with the uncertainty that comes with the region, what can traders do to maximize their chances of strong profits in the long run?
Edward Hindy, chief investment officer at Tier Capital, advises institutional investors to adopt a bear market outlook in light of the May crash.
“Focus on the top 10 coins; don’t be bold,” he advises. “If you’re more risk averse, you can focus on Bitcoin.” The general idea goes the same way as the standard approach to allocating cash during tough times: focus on attracting yield and cash flow positive names.
Hindi continued: “What you typically do in this climate is move your money from altcoins to bitcoins. You see the strength of bitcoin relative to the rest of the alt sphere.
Crypto trading professional
Such methods reflect the increasing professionalization of cryptocurrency trading in recent years and the blurring of the boundaries between the traditional financial world and the crypto realm. Hindi expects this trend to continue, with more institutional investors using their expertise in risk management to profit from the volatility of crypto markets.
This professionalism could leave retail investors – who have constituted the largest number of cryptoholders since Bitcoin’s inception in 2009 – out of the picture. But such an outcome could serve to reduce volatility and further leverage traditional financial players, Hindi said.
“We see the players change. “More institutions will come in, which will stabilize the market as they are less reactive,” he predicts. “They understand the risks and live in it for a long time.”
Regulation is another way for cryptocurrencies to gain the trust of the professional trading community. Although this has been circulating in the crypto world for a long time, discussions have yet to translate into action on any significant scale. But less than a day after the Terra-Luna disaster, US Treasury Secretary Janet Yellen reaffirmed her desire to establish a regulatory framework. If she acts accordingly, she will have the support of President Biden, who in March announced his decision to bring some form of regulation to the market.
Dr. Ying-Ying Hiseh is Assistant Professor of Innovation and Entrepreneurship at Imperial College London and Associate Director of the Center for Cryptocurrency Research and Engineering. She believes that regulation will be a critical enabler of widespread cryptocurrency adoption, but is concerned about its potential to limit innovation.
Although introducing a regulatory framework requires some of the crypto system to be centralized, Hsieh notes that its highly decentralized nature is a key part of what makes the market attractive to retail and institutional investors.
“Decentralization is sustainable,” she says. “You can decentralize the network. You can decentralize the data. Or you can decentralize ownership of the platform. It’s not a binary concept. But regulators have to consult the industry about what should and shouldn’t be decentralized. They need to strike the right balance.”
Crypto is known to be risky, but traders love volatility. Especially when they implement sophisticated trading strategies using powerful algorithms and other sophisticated tools, they are given the opportunity to make money.
And, as the crypto field slowly becomes more professionalized and regulated, May’s crash doesn’t seem like it’s going to sway the trading community. If anything, it’s doing quite the opposite.