Cryptocurrency or ICO investors can find plenty of guidance to help them identify an investment that’s potentially a scam. But what about warning signs that a legitimate crypto venture is about to crash?
While cryptocurrencies are different from traditional stocks and bonds, the same basic market factors tend to be at play: businesses are seeking revenues, investors are seeking profits, and various players are trying to – legitimately or otherwise – drive the market up or down. And, as with traditional investments, recognising red flags in the crypto market is more of an art than a science, with wisdom often coming only in hindsight.
“Bubbles,” as MIT historian William Derringer told Wired shortly before the last cryptocurrency crash in early 2018, “usually get identified in retrospect.”
Still, investors should be alert to potential signs of a coming fall for a digital currency, blockchain business or the crypto market as a whole. Here are four red flags to watch out for:
Possible whale activity
Whales are cryptocurrency investors with holdings large enough to move the entire market when they decide to buy or sell. So the sudden appearance of very large buy or sell orders at a specific price – effectively creating a price wall – could indicate a whale has become active. “Most coins have whales manipulating them, to varying degrees,” software engineer Devin Soni writes on Hacker Noon. “Typically the higher the market cap of a coin, the lower the whale influence is. Note that sell walls are not necessarily indicative of manipulation, as these do occur naturally as well. An easy way to determine if a wall is artificial is to observe its behaviour over time; a whale’s wall will most likely jump around as the price moves as the whale readjusts, whereas a naturally-occurring wall will either stay in one place or move slowly in bits as the price changes.”
Pump and dumps
This is similar to whale activity, only it’s driven by a group of actors – rather than a single whale – working together to drive up and then crash a currency’s price. A pump-and-dump scheme is often preceded by a lot of online chatter among the participants, and tends to target low-liquidity coins and low-volume exchanges. How can investors avoid falling prey to such schemes? The US Commodity Futures Trading Commission recommends common-sense precautions such as not believing promises of quick wealth or no risk. It also notes: “Don’t purchase digital coins or tokens because of a single tip, especially if it comes over social media.”
Bubbles about to burst
The 20th-century US economist Hyman Minsky, whose research in financial crises gained new attention during the late-2000s sub-prime mortgage crisis, identified five stages of a speculative bubble, starting with a new technology or major market change that grabs investors’ interest. From there, the bubble moves through a boom of rising values, euphoria as prices skyrocket, profit taking by savvy investors and, finally, panic by remaining investors. Watch the market carefully for the first four signs if you want to avoid the fifth. As a team of Harvard researchers noted in a 2017 study about stock bubbles: “[A]lthough average returns are hard to predict, the probability of a substantial crash after a 100 per cent return is much higher than it is on average, and in fact rises monotonically as past returns increase.”
Worsening business pains
For investors in an individual crypto or blockchain venture, it’s also smart to keep an eye on the company’s workforce: a business that’s “haemorrhaging employees” might be heading for a crash, even if it’s not yet showing signs of money trouble.