There is good reason to be afraid. Previous down markets have seen declines in excess of 80%. While tightfisted hodling might hold wisdom among many Bitcoin (BTC) maximalists, speculators in altcoins know that diamond handing can mean near (or total) annihilation.
Regardless of one’s investment philosophy, in risk-off environments, participation flees the space with haste. The purest among us might see a silver lining as the devastation clears the forest floor of weeds, leaving room for the strongest projects to flourish. Though, doubtlessly, there are many saplings lost who would grow to great heights themselves if they had a chance.
Investment and interest in the digital asset space are water and sunlight to the fertile ground of ideas and entrepreneurship. Less severe declines better serve the market; better a garden than a desert.
A brief history of crypto bear markets
In order to solve a problem, we must first understand its catalyst. Bitcoin and the wider digital asset space have survived a number of bear markets since its inception. By some accounts, depending on one’s definition, we are currently in number five.
The five Bitcoin bear markets. Source: TradingView
The first half of 2012 was fraught with regulatory uncertainty culminating in the closure of TradeHill, the second-largest Bitcoin exchange. This was followed by the hacks of both Bitcoinica and Linode, resulting in tens of thousands of Bitcoin lost and dropping the market by some 40%.¹ But, the price rebounded, albeit briefly, finding new heights above $16 until further hacks, regulatory fears and defaults from the Bitcoin Savings and Trust Ponzi Scheme collapsed the price yet again, down 37%.¹
The enthusiasm for the new digital currency did not stay long suppressed, as BTC rose again to find equilibrium at around $120 for the better part of the next year before rocketing to over $1,100 in the last quarter of 2013. And, just as dramatically, the seizure of the Silk Road by the DEA, China’s Central Bank ban and the scandal around the Mt. Gox closure sank the market into a viciously protracted retracement of 415 days. This phase lasted until early 2015, and the price withered to a mere 17% of the previous market highs.¹
From there, growth was steady until the middle of 2017, when enthusiasm and market mania launched Bitcoin price into the stratos, peaking in December at nearly $20,000. Eager profit-taking, further hacks and rumors of countries banning the asset, again, crashed the market and BTC languished in the doldrums for over a year. 2019 brought a promising escalation to nearly $14,000 and ranged largely above $10,000 until pandemic fears dropped BTC below $4,000 in March 2020. It was a staggering 1,089 days — nearly three full years — before the crypto market regained its 2017 high.²
But, then, as many in the space have memed, the money printer went “brrrrrr.” Global expansionist monetary policy and fears of fiat inflation fed an unprecedented rise in asset values.
Bitcoin and the greater crypto market found new heights, topping out at nearly $69,000 per BTC and over $3 trillion in the total asset class market capitalization in late 2021.²
The total crypto market cap decline. Source: TradingView
As of June 20, the pandemic liquidity has dried up. Central banks are hiking rates in response to worrying inflation numbers, and the greater crypto market carries a total investment of a relatively meager $845 billion.² More worrying still, the trend indicates deeper and longer crypto winters, not shorter, befitting a more mature market. Doubtless, this is primarily caused by the inclusion of and speculative mania around the high-risk start-ups that comprise some 50% to 60% of the total digital market cap.²
However, altcoins are not entirely to blame. The 2018 crash saw the Bitcoin price drop 65%.⁴ Growth and adoption of crypto’s apex asset have raised regulatory alarms in many countries and questions about the very sovereignty of national currencies have followed.
How to mitigate risk in the market?
So, it is risk, of course, that drives this undue downward volatility. And, we are in a risk-off environment. Thus, our young and fragile garden wilts first among the deeper-rooted asset classes of convention.
Portfolio managers are acutely aware of this and are required to balance a sliver of crypto investment with a larger slice of safe-haven assets. Retail investors and professionals alike often drop their bags entirely at the first sign of a bear, returning to conventional markets or to cash. This reactionary strategy is seen as a necessary evil, often at the expense of incurring short-term capital gains tax, and at risk of missing significant unpredictable reversals, which is preferred to the devastating and protracted declines of crypto winter.
Must it be so?
How does an asset class so driven by speculative promise de-risk enough to keep interest and investment alive in the worst of times? Bitcoin-heavy crypto portfolios do better, comprising a higher percentage of the least volatile of the major assets. Even so, with a 0.90+ correlation of Bitcoin to the altcoin market, the wake of crypto’s most dominant currency often serves as a churn to smaller assets caught in the same storm.
Correlation of BTC to Ether and all altcoins. Source: Arcane Research
Many flee to stablecoins in dire times, but, as evidenced by the recent Terra disaster, they fundamentally hold more risk than their fiat peg. And, commodity-paired tokens are burdened with the same concerns inherent to any other digital asset: trust — be it in a marketplace or its organizational entity — regulatory uncertainty and technological vulnerabilities.
No, merely tokenizing safe-haven assets will not provide the stable yang to the volatile yin of the crypto market. When fear is at a maximum, an inverse price relationship, not merely neutrality, must be achieved to retain investment in crypto and at a return that justifies the adoption of this inherent risk.
For those willing and able, inclusion of the inverse Bitcoin exchange-traded funds (ETFs) offered by BetaPro and Proshares does provide a hedge. Much like engaging short positions, however, accessibility hurdles and fees make these solutions all the more unlikely to sustain the average investor through the bear market.
Further, increasingly regulated and compliant centralized exchanges are making leveraged accounts and crypto derivatives unreachable to many in the larger retail markets.⁵
Decentralized exchanges (DEXs) suffer from the limitations of anonymity and solutions offered for shorting mechanisms on such have largely required a centralized exchange to work in collaboration. And, more to the point, both solutions functionally do not support value retention in the crypto market directly.
Are crypto safe-haven assets enough?
The solution to the mass exodus of investment in the crypto bear market must be found in the assets themselves, not in their derivatives. Escaping the inherent risks mentioned above might be, in the medium-term, impossible. But, regulatory clarification is promised and debated around the globe. Centralization and technical risks are finding new mitigations through decentralized autonomous strategies and the engagement of an ever-more discerning crypto-savvy investor.
Through many experiments and trials, crypto entrepreneurs will continue to bring real solutions to the forefront. Applications of blockchain technology that find substantial adoption in down-market “defensive” industries such as healthcare, utilities and the purchase or production of consumer staples would provide an alternative to flight. Such development should be encouraged in these uncertain times. Rather, by the wisdom of the market, such uncertain times should encourage this development.
However, ingenuity should not be limited to merely tokenizing the feeble solutions of the conventional markets. This is a new world with new rules and possibilities. Programmatically incentivized inverse mechanisms are feasible, after all.
Synthetix’s Inverse Synths aspire to do just that, but the protocol sets both a floor and ceiling price, and in such an event, the exchange rate is frozen and only exchangeable on their platform.³ An interesting tool for sure but unlikely to be utilized by the greater crypto market. True solutions will be broadly accessible both geographically and conceptually. Rather than providing merely a dry place to wait out the down-market storm, crypto solutions must provide a return to justify the risk still inherent to our developing asset class.
Is there a silver lining to the bear market? Will the survivors of crypto-winter emerge in a market more rewarding for application and adoption than speculation? Healthy pruning may be just what our young garden needs; a protracted drought surely is unnecessary. Down markets are simply a problem and, with the clever application of blockchain technology, hopefully, a soluble one.
Trevor is a technology consultant, entrepreneur and principal at Positron Market Instruments LLC. He has consulted for corporate planning teams in the United States, Canada and Europe and believes that blockchain technology holds the promise of a more efficient, just and egalitarian future.
¹A Brief History of Bitcoin Bear Markets | by Mosaic – Medium
² Crypto Total Market Cap (Ticker: CRYPTOCAP): Calculated by TradingView
³ Travers, Garth (July 19, 2019). “Inverse Synths are Back”
⁴ Choudhury, Saheli Roy (January 11, 2018). “South Korea is talking down the idea a cryptocurrency trading ban is imminent”
⁵ Newbery, Emma (August 3, 2021). “Why are so many crypto exchanges unavailable in the US?”