In the second week of May, cryptocurrency enthusiasts around the world stared in awe at their screens as the market crashed before their eyes.
Along with the broader economic instability that had set in over the final few weeks of 2021, crypto assets were generally on a downtrend anyway. But its decline degenerated into a meltdown that reminded some traders of the start of the global financial crisis in late 2007.
The immediate cause was the implosion of Terra – a so-called stablecoin designed to reduce volatility in the crypto market by maintaining a fixed value over time. But unlike other stablecoins, Terra was not tied to a stable reserve asset like gold or the dollar. Instead, its stability was based on algorithms tied to its sister cryptocurrency, Luna. As luna’s valuation plummeted to a fraction of a cent from around $80 (£66) earlier in the month, terra followed suit.
Their collapse caused panic in the market. The price of bitcoin fell to $26,000, 60% below its November 2021 peak, while ether, the next largest cryptocurrency, lost 30% of its value. Coinbase, one of the largest cryptocurrency exchanges, reported a $430 million loss in the first quarter.
Although the market has stabilized somewhat since late May, many cryptocurrency valuations remain noticeably dented. Some major financial institutions, such as the International Monetary Fund, have cited the recent crash as evidence, if more were needed, of the inherent instability of this asset class.
Individual traders bear the brunt
There is an argument that the situation was far worse for individual traders than for large investors. Aidan Mott, an Intel manager at crypto research provider Messari, agrees with this view, noting that such volatility has often prompted a strong recovery in some currencies, particularly bitcoin and ether.
“Retailers are more affected than larger financial institutions,” he says. “Most people using Coinbase or Robinhood don’t have access to the larger pools of liquidity or other financial vehicles that large institutions have. The biggest volatility in bitcoin and ether has caused price increases, which is good for institutional traders. When you have an asset with zero volatility, there is no way you can turn a profit. As an investment, it makes no sense.”
But choosing the right crypto trading strategy is easier said than done. Consistency and quantifiability are at the heart of any successful approach. But given the instability that comes with the territory, what can traders do to maximize their chances of long-term solid profits?
When you have an asset with zero volatility, there is no way you can turn a profit. As an investment it makes no sense
Edouard Hindi, chief investment officer at Tyr Capital, recommends institutional investors take a bear market stance in light of May’s crash.
“Focus on the top 10 coins; don’t you dare leave it,” he advises. “If you are more risk-averse, you could focus on bitcoin. The general idea is similar to the standard approach to allocating money during tougher times: focus on generating returns and focus on cash flow positive stocks.”
Hindi continues: “What you typically do in this climate is move your money from altcoins to bitcoin. You will see the strength of Bitcoin compared to the rest of the alternative realm.”
Professionalization of crypto trading
Such tactics reflect the increasing professionalization of cryptocurrency trading in recent years and the blurring of the lines between traditional finance and the crypto space. Hindi expects this trend to continue as more institutional investors use their risk management expertise to profit from crypto market volatility.
This professionalization could push retail investors – who have made up a sizeable portion of crypto holders since Bitcoin’s inception in 2009 – out of the picture. However, according to Hindi, such an outcome could help reduce volatility and encourage greater adoption by traditional financial players.
“We will see how the players change. More institutions will step in, which will stabilize the market because they are less reactive,” he predicts. “They understand the risks and will be there for the long term.”
Regulation is another way that cryptocurrencies can regain the trust of the professional trading community. Although this has been discussed in the crypto world for a long time, the discussions have yet to be translated into action to any significant extent. But less than a day after the Terra Luna crash, US Treasury Secretary Janet Yellen reiterated her desire to create a regulatory framework. If she acts accordingly, she will have the support of President Biden, who in March signaled his determination to bring some semblance of control to the market.
dr Ying-Ying Hsieh is Assistant Professor of Innovation and Entrepreneurship at Imperial College London and Associate Director of the Center for Cryptocurrency Research and Engineering. She believes regulation will be a key factor in broader adoption of cryptocurrencies, but is concerned about their potential to limit innovation.
Although introducing a regulatory framework would require centralization of certain aspects of the crypto system, Hsieh notes that its highly decentralized nature is a key part of what has made the market so attractive to investors, both retail and institutional.
“Decentralization is a continuum,” she says. “You could decentralize the network. You could decentralize the data. Or you could decentralize ownership of the platform. It’s not a binary concept. But regulators need to consult the industry about what should and shouldn’t be decentralized. You have to find the right balance.”
Crypto is notoriously risky, but traders like volatility. It gives them an opportunity to make money, especially when they employ sophisticated trading strategies using powerful algorithms and other sophisticated tools.
And as the crypto field gradually becomes more professional and controlled, May’s crash doesn’t seem to deter the pro trading community. If anything, it does exactly the opposite.
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