The Investor’s Guide to the Crypto Bear Market

Crypto bear markets present a rare opportunity to not only accumulate holdings but to position yourself to outperform by prudently managing your risk. However, the reality is that most investors fail to accomplish such feats during bear markets. A large part of this can be attributed to a lack of extensive knowledge regarding what constitutes a bear market and a failure to learn how sophisticated investors navigate bear markets.

This guide addresses these knowledge gaps. Readers will learn the detailed phases of bear markets and how long such downtrends have lasted historically. With help from the experts at OKX, we will dive deeper into historical bear market cycles both in crypto and traditional markets and learn how institutions ride the wave to generate sizable returns. To start off, it is important to define what a bear market is.

What is a bear market in crypto?

A crypto bear market is a period of prolonged and often volatile decline in the price of nearly all assets. The general definition of a bear market in traditional financial markets is when asset prices fall 20% or more from recent highs in the midst of negative sentiment regarding price prospects. By extension, a crypto bear market, widely known as a crypto winter, is a similar decline in the price of cryptoassets across the market and often results in some projects being wiped from the market as they struggle to raise funds and meet both users and investor expectations. 

A crypto bear market begins with a demand-supply imbalance that sees most market participants on the sell side. Fear and uncertainty begin to creep into frothy market conditions and selling starts to outweigh the demand side, resulting in significant declines that fail to recover quickly. From a technical perspective, this is reflected by a series of lower lows and lower highs on a longer range timeframe chart such as the weekly as illustrated below with a chart that pinpoints the highs and lows formed since November 2021 in the bitcoin market.

Does the price action between November 2021 to August 2022 suggest that we are currently in a bear market? The short answer: Yes. Since hitting an all-time high in market capitalization, the crypto market has seen an extended drop with most assets currently trading more than 50% from those historical highs. 

Breaking down bear market phases

Investors undergo contrasting feelings at different stages of bear markets. From the initial denial of the inevitable to incessant buying of dips to the feeling of being completely defeated. Bear markets can be further broken down into distinct phases — preliminary, early-stage, full-fledged and late-stage.  Here’s a description of each stage which together make up a crypto winter.

• Preliminary: This phase begins right after assets reach their peak prices. Because market sentiment has remained bullish for a long period, participants maintain excessive optimism about a swift recovery when an initial pullback occurs. This can be often seen in the funding rates of perpetual derivatives instruments which are pushed higher as speculators take long-side positions with leverage. The chart below shows funding rates spiking in October, preceding the initial phases of the current bear market.

• Early-stage bear market: The early-stage bear market is marked by some significant downside movements but also recoveries. Most market participants remain optimistic of a recovery to new heights, spurring significant buy-side pressure. However, the recoveries fail to cover the extent of the downside movements, resulting in large red candles and somewhat smaller green candles on longer time frame charts.

• Full-fledged bear market: This is the main bear market phase marked by significant downside, with little or no upside movement across higher time frames. Investors move beyond their denial of the impending drop and begin offloading their holdings en masse. Although there may be “relief” rallies on shorter timeframes such as a day, a majority of assets end up retracing 50% from their peaks at this stage, with significant recoveries few and far between. Crypto-native companies begin to downsize, while the market begins responding poorly to negative news.

• Late-stage bear market: This is the stage where market bottoms form and the downside slows. The market reaches a price that is attractive enough for the demand side to start entering en masse. There are little to no sellers left while buyers have a stronger conviction that they’re getting assets at fair value prices. The current crypto market conditions suggest we may be at this stage, with downturns slowing and market conditions either consolidating or slowly increasing.

Examples of crypto bear markets

The roughly decade-old cryptocurrency space has had its fair share of bear markets. A closer review of these historical performances offers insight into what causes them and how long crypto bear markets typically last.

2014/2015 bear market

The first large-scale crypto bear market marked the aftermath of a largely surprising bull market in late 2013. First, an alleged market manipulation at the then-largest crypto exchange Mt. Gox pushed the BTC price from $200 to a new all-time high of around $1,236. 

The volatile increase (between early November and December 2013) was quickly followed by a steep decline as most market participants sought to book profits in a low-liquidity market. The result was a full-blown crypto winter that lasted for two years with the global market cap dropping from $15 billion to around $3.5 billion at its lowest point in early 2015.

As the above chart reveals, it was not until mid-2015 that the markets finally showed signs of recovery. It also took an extra year for prices to recover to the previous high, effectively ending the longest crypto winter to date.

2018 crypto winter

After hitting an all-time high of around $20,000 in early 2018, bitcoin (and the rest of the crypto market) was in for one of the longest periods of steady price declines. Following a nearly 12-month grind to the bottom, bitcoin would end the year trading around $3,200 with the global market capitalization dropping from $820 billion to just above $100 billion.

The price drop was largely attributed to an overheated market where most projects lacked fundamentals. Sell-offs were exacerbated by US authorities suing a number of top projects for conducting alleged securities offerings in the form of initial coin offerings (ICOs). The crypto winter lasted for roughly a year, ending with a mini bull market in early 2019. 

2022 bear market 

According to Lennix Lai, head of OKX Institutional, the 2022 bear market is fundamentally different from the two previous two ones: “This bear market isn’t only caused by crypto specific idiosyncratic risks like the Luna crash and central lending insolvencies from 3AC, Voyager, and Celsius. It is also caused by crypto’s increasingly high correlation to traditional financial markets and macro risks like inflation, energy prices and the Russia-Ukraine war.”

According to a recent report from Arcane research, bitcoin’s correlation to the NASDAQ and S&P 500 sits at a high of 0.5.  

The correlation has remained somewhat consistent from the beginning of the year. The collapse of Terra/Luna caused a sharp departure in March and a series of liquidity issues from centralized crypto lenders triggered a second departure in mid June.  

Both of these events, however, were preceded and potentially even precipitated by negative macroeconomic dynamics. For example, prior to the collapse of Terra/Luna, bitcoin saw strong S&P 500 and NASDAQ correlation in April. Markets were trending downward as many were pricing in the coming Fed rate hikes. These forces caused investors to move away from risky assets and exposed liquidity vulnerabilities in crypto. This combined with Terra/Luna’s faulty algorithmic pricing model ultimately created the environment that allowed a series of trades to collapse the stablecoin. 

Terra/Luna was ultimately one domino among a series of macroeconomic forces. Its fallout helped expose greater liquidity vulnerabilities in Celcius and 3AC, but it was not the single cause. 

For example just days prior Celsius freezing all withdrawals, news about US inflation data broke expectations and sent markets tumbling. The news increased sell pressure to a point where Celcius could no longer support withdrawals. It was the straw that broke the camel’s back. But under that straw lay a hay bale of market forces, including the conflict in Ukraine, supply chain issues, labor shortages, central bank monetary policies and a global debt crisis.   

How traditional bear market investment behavior compares to crypto

The severity of declines often depends on the stage of development of the market. Typically, the more established the asset class and the greater capital base underpinning it, the lower the volatility and downside risk will be. For instance, the below chart illustrates that while the US stock market has also suffered some prolonged periods of declines, its declines have been less pronounced with the lower-cap Russell 2000 Index underperforming the higher-cap S&P500 and bitcoin radically underperforming both.

When global markets are highly volatile, there is a “flight to quality” by investors. In the stock market, investors rebalance portfolios by shifting positions from small cap to mid-cap to large cap equities; and in the broader asset classes, multi-asset managers move from equities to corporate bonds to government bonds or gold. Since crypto is more volatile and has a smaller market cap than other asset classes, it experiences exponentially larger downward pressure in prices.   

However, on the other side, more volatile and severe bear markets such as those that occur in the crypto industry also present more opportunities to prudent investors who can balance their risk and position themselves effectively. Those that can identify a bear market in the early stages can preempt downturns by transitioning into cash or lower-risk assets while those that can identify a bear market in its later stages may accumulate holdings at extremely attractive price levels.

How institutions trade differently in crypto bear markets

Institutions are among the most sophisticated entities when it comes to trading in bear markets. Dubbed “smart money”, institutions often sell during periods of excessive optimism and buy during periods of irrational fear. 

The same phenomenon applies to crypto winters, both prior ones, and current ones. For instance, when bitcoin dropped below $30k in July of 2021 after roughly six months of declines, prominent proprietary trading company Alameda and other institutions invested capital. We are observing a similar trend in recent months with roughly $474 million flowing into digital asset traded funds from institutional investors in July.

In times of market stress, however, investors face heightened volatility, illiquid order books, and challenges in accessing credit lines. For these reasons, they often tend to focus on two goals, especially when large pools of capital are involved: trading at the best available price, with the smallest market impact.

This is why many institutional investors in crypto have come to favor block trading during bear markets. Block trading allows them to stealthily execute large trades that would otherwise trigger major buy or sell signals in the order book. These trades also avoid the typical price slippage that comes with large market orders. OKX recently launched their own block trading service for pro and institutional traders. They use RFQ large-sized spot, derivative, and multi-leg structures to prove tight execution prices. In their guide, they explain how block trading works and why it’s important.

Final note

As institutional interest in digital assets grows, so will the correlation between crypto and traditional markets. And as opportunities in DeFi, the metaverse and crypto markets converge into a mature and well defined sector, there may even be a future where digital assets lead traditional markets.  

Regardless of timing, it is likely that this trend will prevent the crypto market cycle from returning to the popular stock-to-flow pricing models of previous cycles. Even though no one can time the bottom of a bear market, the experts at OKX believe that there is still an opportunity to prepare for the next bull cycle. Check out some of their industry insights to learn more.

This content is sponsored by OKX.

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