Mainstream media loves to print headlines predicting a Bitcoin crash. They harp on cryptocurrencies being a volatile market as if the United States housing bubble in 2008 didn’t burst and investment banks such as the Lehman Brothers didn’t crumble. However, Bitcoin is indeed an investment. Thus, like any investment, its value can move up or down and, potentially, crash.
When they crash, Bitcoin and other cryptocurrencies cannot drop to a negative number. Thus, while the value of an investor’s Bitcoin will have fallen, the investor does not “owe” money to anyone. However, if the investor bought Bitcoin using their credit card, they will still be liable for the credit card debt from when they first purchased the Bitcoin.
Cryptocurrencies, including Bitcoin, cannot drop to a negative value. So, while it is understandably disappointing not to be able to sell that cryptocurrency for the price you paid, a crash can’t send an investor into negative territory. That is unless the investor had decided to play a high-risk strategy that involves using their crypto as leverage. For most, though Bitcoin is very similar to Gold, it is no one’s liability.
Cryptocurrencies rise and fall like any other investment, and sometimes that fall can be significant. An alt-coin (coins that are not Bitcoin) could potentially reach 0, exchanges stop hosting it, and all you are left with are codes on a wallet. This is disappointing but isn’t necessarily the train wreck most would have you believe.
Buying Bitcoin is like buying a house. If the home is paid for and the owner doesn’t plan to sell anytime soon, the ups and downs of the house price do not matter much. Only once the house is sold will the owner have made a profit or loss.
Thus, if a cryptocurrency has “crashed,” similar to the 2008 US housing market, it is stressful for those who own coins, especially if the owner is highly leveraged and has to sell. But for those holding on to their investment, the crash matters little, as long as the coin regains some of its value before they need to sell. However, as we have taught our students at DWG, we never advocate people invest money that they ‘need’ for their day-to-day needs. Therefore you should never ‘need’ to sell your Bitcoin to cover the cost of food or housing.
It is not common for an investor to owe anyone money after a cryptocurrency falls in value. However, there are a few potential situations where this could occur. But none of these situations involve the cryptocurrency price straying into negative value. The lowest a cryptocurrency can reach is 0.
Many exchanges allow investors to buy cryptocurrency using a credit card. The price charged to the card is the amount the coin cost at that moment, plus any fees added on by the exchange. The amount on the credit card is fixed and will not be adjusted if the coin’s value changes before you pay off that debt. So, even if the currency’s price drops to 0, you will still owe the credit card company for the amount you agreed to at the time of purchase. Therefore, we strongly suggest you never use debt to buy any investment.
Generally, your wallet at an exchange does not drop below zero if you don’t use leverage. However, it can happen only with your bank, but again, it typically has nothing to do with your cryptocurrency but your bank.
For example, let’s say you purchase cryptocurrency with your debit card. The cryptocurrency is transferred to your account by the exchange. However, if your bank reverses the payment for some reason, your exchange will deduct the total cost of the transaction from your wallet on the exchange.
Investors rarely leave their entire crypto investments in these “hot” wallets. Because you pay for fees and the cost of the coins, you likely owe more than the total sum of cryptocurrency sitting in your exchange wallet. Thus, you end up with a negative value balance in your exchange’s crypto wallet.
Some investors like to up the stakes and venture into risky money-making strategies such as shorting or using leveraged products and strategies. They will sometimes use their Bitcoin or another cryptocurrency as collateral to make these investments. Still, if the currency/collateral you used falls in value, this could leave the investor owing money.
If there were a cryptocurrency crash, there would be many unhappy investors. However, in 2019, the ‘Financial Stability Oversight Commission’ released a report on the significant challenges to financial stability. The report did not view cryptocurrency as a powerful destabilizing force in the event of a crash. Instead, they believe the number of people invested in cryptocurrencies isn’t large enough. The entire market cap of the Crypto Universe is still less than $2 trillion. That may sound like a lot, but when you compare it to the total market cap of all listed stocks (about $90 trillion) or bonds (about $120 trillion) then, you can see how small the Crypto universe actually is (and how early you as an investor are!)
However, if the Crypto universe continues to grow at the breathtaking rate it currently is, within a decade, the total cryptocurrency market would be big enough to cause a significant economic event if it crashed. The impact would be even greater if people took out significant loans in fiat currency to invest in cryptocurrency; however, this is not a worry for the time being.
When putting together a long-term investment plan, it is crucial to consider what you will do if the value drops. You never want to invest based on how much you can make. Ideally, your entry point in a market is based on how much you can bear to lose. The digital marketplace is known for lots of movement in both directions; ideally, you want to have a plan before the numbers begin to move. This will help you avoid impulsive decisions based on panic or FOMO (fear of missing out).
Thus, the first question to examine before investing in cryptocurrencies is why you are doing it? For example:
At DWG, we encourage buy and hold strategies. But we understand that everyone has different wants and needs regarding investing goals. What is crucial is that you, the investor, are honest with yourself about your aims. You sabotage your success if you make a plan for a strategy you know you won’t follow.
If you have a good investment plan, staying calm when the numbers move is easier. You know your boundaries and what to do if the situation crosses them. So, your decision will be well thought out and not impulsive, limiting the chances of regret later on.
If you want to learn more about creating a long-term financial plan in the cryptocurrency market, feel free to contact us. We are always here to help.
Bitcoin and other cryptocurrencies do shift in value. However, there is a limit to how far down they can go. Cryptocurrencies cannot be worth less than 0. So, investors will generally not owe money even if a cryptocurrency crash occurs. But the best way to navigate the fluctuating values of cryptocurrency is by creating a long-term plan with strategies in place before you invest.
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