Lessons To Learn From the Recent Crypto Crash

Lessons to learn from the recent crypto crash

Cryptocurrency (crypto) performance and crypto exchanges has been in the news recently. From the significant loss in value of cryptocurrencies to the failures of several high profile crypto exchanges and funds, you’d be forgiven for thinking that the end is near for crypto as an asset class.

For many crypto investors this painful experience is likely to put an end into their crypto investment forays for a long time, perhaps for good. Many inexperienced investors (at least inexperienced in crypto) jumped into the red hot crypto markets buoyed by the crazy returns many were making (as well as FOMO) and invested significant sums (in many cases most of their net wealth) only to see the crypto industry crash and losing significant net wealth in the process.

Unfortunately this is just an example of many of the historical hype investments that captured public imagination, from the Dutch tulip craze in the 1630’s through to the recent crypto frenzy where small fortunes were created in the manic run up, only to flame out with millions losing out in the subsequent crash. So what are the lessons learned from the recent crypto market meltdown and what steps can investors do to make sure they aren’t caught out again?

1. Never, ever invest more than you can afford to lose

With the recent difficulties and bankruptcies of several crypto exchanges, lender and crypto focused funds we are beginning to hear some sad stories about investors losing significant portions of their net wealth. A recent CNBC article covering the fallout of the failure of Celsius the crypto lender shared some sad tales.

From elderly retirees on welfare through to families struggling to keep a roof over their heads, the fallout has been devastating for the many small investors caught up in this failure. Given that cryptocurrency is an unregulated investment if things go bad you can’t rely on the government to help you out. 

Before making an investment (especially more risky investments) always ask yourself “if this investment goes belly up, how will this affect me financially?”. If it would crush you then you should avoid it and only investment a small amount.

You want to live to fight another day in investing. Going all in on a risky investment almost never produces a happy ending. No one likes to lose money on an investment, however that is the risk you take when investing. It’s the hit to your net wealth you can limit by only investing an amount that won’t ruin you financially if it dropped substantially or went to zero.

2. Know your risk profile or appetite for risk

Many investors (particularly elderly retirees) jumped into the crypto game only hearing of the great returns that seemed to be generated by investing in crypto or the relevant exchanges. Unfortunately crypto (and other alternative investments) can be very risky.

As we’ve written about previously different investment classes attract different levels of investment risk. From cash through to fixed interest, property, shares and alternative investments, there level of risk increases. When investing in an unregulated field this increases that level of risk even more.

If you are younger there can be a more risk tolerant approach to your investing, particularly as you have many more years to make up potential losses. Compare this to a retiree who doesn’t have the ability to earn back any losses through their job and understandably their risk profile will be skewered more towards ‘safer’ investments.

Understand the true risks of a particular investment or asset class and reach out to an investment professional should you wish to discuss this in more detail. At the end of the day you have to be able to sleep at night and understanding your investment risk will help this.

3. Diversify and limit your investments into riskier investments

Further to the above point, once you understand how comfortable you are with risk, make sure you invest around this risk profile and diversify your investments. Don’t make exceptions just because an asset class seems to be offering never ending positive returns.

Good times won’t always last in investing, plan your investment portfolio taking this into account. For those who have invested 5% of their total investment portfolio into crypto currency or crypto exchanges will be feeling a whole lot better than someone who invested 50% or more into crypto at levels close to 2021 highs. 

Now some people will say that investing in crypto is bound to fail, while others will flash their diamond hands and believe crypto is going to the moon! Either way by diversifying if it doesn’t underperform or fail your investment plan hasn’t been sunk and if it does perform well you still have a piece of the action.

Considering the underperformance of the crypto sector has occurred during the same period of the underperformance of many bonds/fixed interest investments and many listed shares and sectors, a portfolio diversified with investments in cash (excluding inflation issues), property, energy or some stock market protection assets would have smoothed out any crypto, share or bond market underperformance.    

4. Always read the fine print and do your research

Looking at the Celsius failure again, many investors were caught up in the Celsius terms and conditions. As per the CNBC article,

“Also in the fine print of Celsius’ terms and conditions is a warning that in the event of bankruptcy, “any Eligible Digital Assets used in the Earn Service or as collateral under the Borrow Service may not be recoverable” and that customers “may not have any legal remedies or rights in connection with Celsius’ obligations.” The disclosure reads like an attempt at blanket immunity from legal wrongdoing, should things ever go south.”

Whilst the likelihood of the bigger creditors of Celsius such as big Crypto player Alameda Research getting some return on their capital, smaller retail investors are likely to get very little if anything at all.

If you invested in a listed company you have benefit of being able to access a fully audited prospectus or annual report outlining income, expenses, profits (or losses), assets and liabilities. This will allow you to gauge the financial health of the company before you invest. Now this isn’t totally foolproof (look at companies like Enron) however by doing your research (and using diversification) this will limit your risk.

A similar example can be seen with bank accounts, where by having your funds in a FDIC (in the USA) insured bank you are insured for up to $250,000 per depositor, per insured bank (other countries may offer a similar government guarantee).

If you struggle with some of the details of financial research then reach out to a financial professional for more help.

5. Keep regular investing (only a small amount) if you still believe in an investment

It’s nearly impossible to time the markets and many people have lost a lot of money trying. If high prices for an asset concern you or if you are scared that the bottom hasn’t been reached for an investment you are interested in, an option to mitigate these concerns is to use the dollar cost average approach

Rather than investing a large lump sum into an investment or asset class, you can employ the dollar cost average approach as a way to avoid investing all your money at a high and is a great way to purchase assets at a lower price. Case in point is the current sell off in the share market and crypto sector. If your investment thesis still stacks up and you are still keep on these investments by all means keep adding to your holdings.

If it works out as planned then you have picked up some quality assets on the cheap and when the price goes back to its previous high levels your portfolio will be looking very healthy.

You can use a similar approach by reviewing your holdings and taking profits by selling some of your portfolio when the price gets abnormally high, buying back in later if the investment is still a quality one in your eyes at a lower price.

While this significant downturn in the fortunes in crypto may be a much needed shake up, it’s not necessarily the end of the sector. Surviving this pull back (not only in crypto in most investment markets) shows that diversification is a key to dealing with market downturns. Better yet, diversification and having access to liquidity enables you to withstand significant market down turns and to take advantage of buying opportunities due to these dips in the price.

Stick to your investment plans, have confidence in yourself and invest for the long run.