Lessons from The Great Crypto Crash of May 2021

Last week I wrote about crypto and said it was in a bubble:

Yes, this is a bubble. Yes, lots of punters will get rekt (as the lingo goes). Traders gonna trade and it’s not my job or your job to save them.

It would have been good if my time machine had been working a little better and I had got into the crypto market a little earlier (~2011 would have been nice). Or a little later (like yesterday, after the crash).

But we are where we are and on this blog we are in the business of learning…and what a time it’s been for that!

Wednesday was an amazing day in the cryptocurrency markets. At one point on Wednesday Ethereum (ETH) had crashed down 40% in one day…and then bounced up by 35% within one hour.

When I got back from the gym, I fired up my laptop and watched my screen as everything crashed. At one point, I couldn’t get onto the Coinbase site and wondered if this was The Big One…the meteorite strike that wiped everyone out? Could everything go to zero?!?

It reminded me of what free markets look like with no bailouts, and no central banks stepping in to support the price. I was only 17 at the time but it must have been a bit like the great stockmarket crash of 1987 when the S&P 500 fell 30% in a couple of days.

Market crashes like this teach us humility. As investors we have a view on where things will go in the future. But we could always be wrong. In the markets, you are either humble or you will be humbled.

As a relative newcomer to crypto-world, this was my first big crash. It’s nothing personal, crashes like this have been happening for a long time before I got involved. These crashes have historically been the price of admission that you pay for outsized returns.

Investing is a mental game as much as anything else. Crashes are part of the process and so forewarned is forearmed. Your mindset matters…especially as crypto is much more volatile than equities.

I think of Bitcoin as digital gold but with much more volatility. I think of other blockchains such as Ethereum, Polkadot and Cardano as more like early-stage venture capital. They are fintech projects; software networks that are being built out in real time. They’re like toddlers that are growing, changing and evolving. Maybe they will grow up to be the Googles of the future? Or maybe they won’t.

When you have venture capital businesses that are marked to market in real time, wild price volatility is baked into the cake. If you buy the tokens of these platforms, you have to be ready for the possibility that one or maybe even all of them could go to zero. Or to the moon 🚀 as they like to say in crypto-land.

This is how price discovery works in a pure free market. Yes there will be crashes but that is all part of the process. The crashes clear out the froth, the leveraged players and the reckless gamblers from the market. It’s like those forest wildfires that clear vegetation and allow for new growth. The process may seem scary but it is all part of nature’s plan. Nature can be fierce as well as beautiful.

Strangely enough, I felt a sense of peace and detachment as I watched my direct crypto holdings crash alongside my stockmarket plays on crypto. This is partly down to age experience and partly down to a position size that wasn’t too big for my risk tolerance.

And it was a reminder that you should never use leverage in the financial markets for risk assets such as equities or crypto:

Hopefully you are a sensible stockmarket investor and carried on serenely through this. I appreciate that crypto may not be your cup of tea – and that’s okay – but there’s a lesson here for all investors.

What can the great crypto sell-off teach stockmarket investors? Well, quite a lot about handling volatility.

Here we need the mental model of exposure therapy, a technique used to treat anxiety disorders. Exposure therapy involves exposing the target patient to the source of the anxiety in a small and safe way. The exposure is gradually built up over time to help people overcome their anxiety or distress. So if you were terrified of spiders, you would start by looking at a toy plastic spider 20 metres away. Over time (maybe weeks and months) it gets moved closer until eventually the patient could hold it.

Here’s the analogy for investors. What if you could do the same for your fear of volatility?

If you had say £100 in Ethereum (ETH) on Wednesday, it would have been interesting and educational…and hopefully not too scary.

This is a way of learning what wild volatility feels like but with small and safe amounts of money.  Not with your pension. Not with your life savings. Not with your sensibly invested Vanguard Global All Cap Index Fund (or whatever you choose as your main investment vehicle). Crypto is obviously not a replacement for stockmarket investing. But it can provide an accelerated learning process for a small amount of your money.

One of the reasons that crypto is a tricky one for financial independence types is that we have trained ourselves to be sceptical of anything that looks like a Get-Rich-Kwik scheme. Yet crashes like Wednesday remind us that there is no reward without risk.

It is after such crashes that we get the best opportunity to dip a toe in the water. If not now, then when?

My suggestion is that everyone who is curious should learn how to buy and hold say £100 of ETH. It’s like electricity: you don’t need to be an electrical engineer to turn on your lights at home. You will learn something about markets, something about volatility and maybe something about your tolerance for risk?

First things first. You must get out of all expensive consumer debt before you venture into the stockmarket…let alone crypto. That means repaying all money on credit cards, overdrafts, car loans, leases and all the rest of the nonsense.

The more solid your financial foundations, the bigger the cathedral of wealth that you will be able to build on top of those foundations.

If you do choose to play in crypto, start small, play safe and remember the advantages of baby steps.


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7 comments

  1. Eleanor · · Reply

    Would love to read a post about how to invest £100 to learn more about crypto )

  2. Participating in a market without circuit breakers also helps to remind us that the stock market, for all its benefits, is not so mystical and pure and untouched.

  3. there are surely good volatility and mindset lessons to be had with small amount of money. i hope the newer investors learn and keep going rather than get scared out for too long.

    1. Hi Greg – thank you for posting that. I always want to see the bear case for any investment that I’m considering or already exposed to. So if anyone else has high quality bearish analysis (no mainstream media dross pls) on existential risks to crypto, I’d love to see it.

      1. Also, I found this counterpoint piece in the course of reading more about the topic. I still believe that the original author has a clearer picture of what’s really going on (to the extent that any single person knows anything about how this all works), but it’s worth reading and drawing your own conclusions.

        https://bitcoinmagazine.com/markets/debunking-misconceptions-from-the-bit-short-inside-cryptos-doomsday-machine

    2. Peter · · Reply

      Hi Greg, thanks for sharing that article!
      It’s interesting to see that the result of the mentioned investigation was that Bitfinex and Tether should cease all activity in New York. (“An agreement with iFinex, Tether, and their related entities will require them to cease any further trading activity with New Yorkers”)[1]

      The official Tether website makes no mention of that in the news section (also their “Transparency update” is using 3 year old data on the website).[2]

      It is also interesting to see that actual USD makes up only less than 4% of their reserves.[3]

      And this is the stuff that most people buy with their actual money in order to be able to purchase crypto. I have a very-very bad feeling about how this is going to end.

      [1]https://ag.ny.gov/press-release/2021/attorney-general-james-ends-virtual-currency-trading-platform-bitfinexs-illegal
      [2]https://tether.to/
      [3]https://siliconangle.com/2021/05/13/tether-releases-reserve-breakdown-3-87-us-dollars

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