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Why Does Crypto Crash So Often? Understanding Market Cycles

By Evan Jones06/27/2023

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The volatility of cryptocurrency assets can be both beneficial and devastating depending on when you buy-in. Digital assets can increase in value dramatically overnight, but just as easily drop back down to where they started, or worse, go to zero. While it is hard to predict just when these events will happen, it helps to understand what a market cycle is, and what phases they are composed of. 

Once you’re more familiar with the general structure of a market cycle it’s easier to judge if you’re getting in or out of the market at the right time. Let’s start by defining a market cycle before getting into its phases.

What Are Market Cycles?

A market cycle generally refers to trends or patterns that emerge during different phases of a business’ growth. During market cycles, certain investment types outperform others because they’re in the right position for growth relative to others. They’ll increase in value, often quickly, before settling into a new valuation, which can then cause the price to decrease or level off until a new cycle begins.

New market cycles can be spurred by meaningful innovation, new products, or changes to the regulatory environment. A good example of a recent market cycle that was sparked by innovation is the growth for AI companies that’s related to the mainstream success of ChatGPT. 

During cycles triggered by innovation, revenue and net profits may see similar growth across many companies within that sector. This occurred with the ChatGPT success, as both regular and crypto-based companies saw increased investment, but then most experienced plateaus or drawbacks in price.

The caveat to market cycles is that they are hard to define until after they’ve happened and rarely have a specific, clearly identifiable beginning or ending point. However, they are thought to have four phases.

Four Phases of a Market Cycle

Market cycles are typically defined by four phases: accumulation, mark-up, distribution, and downtrend. Let’s break down what each phase tends to look like before discussing how long they may take.

Accumulation

The first phase of a market cycle is referred to as the accumulation phase. This phase usually starts after a downtrend phase (the 4th phase), which is when the market has either crashed, dropped significantly, or stagnated. Many investors have sold off their holdings for profit by this point. Those that haven’t have to decide to sell now, or wait out the cycle. For more experienced or confident investors, the sentiment is that the bottom is likely in, so they stand a good chance of making profit on any trade. They expect that the market will rebound soon, and so they seize the opportunity to invest at a low entry point. This is also referred to as “buying the dip.” 

Accumulation phases generally have low price volatility for assets, along with low trading volume. The only parties really buying are institutional investors with the means to buy the dip. Retail investors may jump in if positive news regarding an asset comes to light, unless they’ve been waiting to buy in, in which case, this is their best opportunity to buy. 

As you might expect, the accumulation phase is defined by accumulation of an asset over time, with the aforementioned low price volatility.

Mark-Up

During the mark-up phase, prices increase. The market trend is clearly upwards at this point, which is why the mark-up phase is often referred to as a bull market.

The upward price movement can be seen as a good time for new market participants to enter, as it’s easier to see the market trend. Dips or retracements during this phase are often seen as buying opportunities, as earlier investors take profit, rather than a sign of the downtrend phase. 

As prices continue to increase, new investors get drawn in because they are afraid that they’ll miss the boat and so they buy-in too. This creates large price swings to the upside and often overvaluations of an asset. This is when the early adopters can really start to take profit.

Prices will soon start to slow down their rise and/or level off as the market reevaluates the asset’s price. The last group of investors, who were undecided about entering the market, will see this as a buying opportunity. This will cause one more peak in price before the market cycle enters the distribution phase.

Distribution

The distribution phase is the end of the mark-up phase. Asset prices flatten as buyers and sellers in the market are battling with each other. Some investors are still looking to buy because they believe the bull market isn’t over. Opposing them are sellers who want to take their profits because they think the bull run is over. 

Prices tend to be stuck around a certain level during this phase (range bound). There is still a lot of trading that occurs during a distribution phase. It’s referred to as the distribution phase because the investment asset gets distributed to more parties than during the accumulation phase, as early investors sell to newcomers.

A distribution phase can take weeks, months, or even years to end depending on the asset and its market. However, range bound prices tend to create uncertainty in the market, and this uncertainty will slowly tip the scale towards a downtrend. This like negative sentiment, adverse news stories, and uncertainty can combine to create a dump, ending the distribution phase and starting the downtrend.

Downtrend

The downtrend phase, sometimes called the markdown phase, is the end of the distribution phase, and signals the beginning of a bear market.  From a technical analysis view, the downtrend phase is defined by a chart that’s dropping and a high volume price decline (meaning lots of selling).

The more that investors fear the market has topped and will continue to drop, the more selling pressure builds. This can create a cascading effect that sends prices of the asset to levels not seen since the mark-up phase, especially for risk assets like cryptocurrencies.

Bitcoin is a good example of this. It hit an all-time high of almost $70k USD, and dropped all the way back down to its previous high of $20k before it started trending back up again.

How Long Does a Crash (Downtrend) Take and Last? 

A downtrend can happen overnight if the reason for it is bad enough, but there’s no set amount of time it’ll take to occur. The length of time that a downtrend lasts once it’s underway depends on a variety of factors, not the least of which is why the crash began. For an asset like FTX Token (FTT), which was the native asset of the now infamous FTX Exchange, it will never regain its value. The same can likely be said for Terra Classic (LUNC). 

However, if an asset simply trended up and down through a natural market cycle (meaning no major negative event to tank its price), the length of time it stays down is fairly hard to predict. If there is no reason for the asset to trend back up it will likely stay down, which may be the case for certain crypto assets until regulation is in place. Assets like those named as securities in the SEC lawsuits against Coinbase and Binance are likely in this category.

Otherwise, it can be days, weeks, months, or years, with the reality being that you can’t truly predict how long an asset will stay in the downtrend phase before accumulation starts taking place (if at all). You then need some sort of catalyst to begin the mark-up phase.

How Fast Can an Asset Increase in Value (Mark-Up)?

Much like a downtrend, a markup phase can happen overnight. But the speed at which an asset will increase in value is incredibly hard to predict, otherwise it would be easy for traders to decide when to buy and when to sell.

As an investor at any level, it’s important to do your own due diligence and only invest what you can afford to lose. Buying an asset because everyone else is isn’t a good reason to do so, and doing so can often leave you on the wrong side of volatility. Always keep market cycle phases in mind when looking at an investment opportunity. 

Article tags

Beginner
cryptocurrency
trading
Evan Jones

Author

Evan entered the crypto scene in 2017, attracted to the many disruptive possibilities that blockchain could have on current world systems. He has a keen interest in decentralized services, payment processing, and viable NFT use cases such as event ticketing. He spends his days writing with his dog Kobe under his feet, if not on his lap.

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