Why do crypto prices fall

Unless it is a stablecoin, crypto prices fall for a number of reasons. In this article, we explore some reasons why they can fall in prices and how you can react to it.

Why do crypto prices fall

Cryptocurrencies are generally volatile investments, except stablecoins of course, which are pegged to a stable asset like USD.

The wild swings in prices might put off many investors because they cannot stomach the volatility, and sometimes, when the price of a cryptocurrency falls, they panic sell too early, only to see it march higher 10x from their lows.

We evaluate in this article several reasons why the prices of crypto assets can fall and how you as an investor can react to it.

Team and early investors sell

Most team members of a project hold a significant proportion of the tokens. The team allocation can range from between 10% to 50% depending on how the project’s tokenomics is structured, and this can create significant sell pressure.

If team members or early venture capitalists sell their share of the tokens, either for personal reasons or a lack of faith in the long-term project direction, the market can detect these sell transactions and possibly sell their tokens to front-run a negative price spiral.

This creates a cascading price dump where a lower price creates even more sell pressure, causing the price to dump quickly.

Whales sell

Whales are investors that can significantly move the market, because they hold a large percentage of the project token.

When whales holding the token sell, they could be taking profits to chase the next project. As such, when whales of small cap projects who usually control a large percentage of supply sell, they can significantly push the prices of the project down.

To find out the whales of a token, you can use a block explorer to check the Holders page.

Top 10 holders of YFI token on Ethereum

Look out for addresses based on the % of supply which are EOA, and track their behaviors. Are they dumping or buying? Whales usually control much of the cryptocurrency market and hence, can highly manipulate the token prices.

Degrading meta

The meta or narrative is a key driver of prices in crypto, as most cryptocurrencies do not have prices anchored on fundamentals.

For example, in the meta of “DeFi 2.0" where DeFi protocols with protocol-owned liquidity were described to be game-changing, many of the DeFi 1.0 tokens like SNX, MKR and AAVE started to fall — because they lost the narrative to new players.

It’s not about how good the project is, but which project the money is chasing based on the prevailing meta.

Poor marketing and perception

Crypto investors love well marketed projects, and you can tell from the top projects on the first page of Coinmarketcap or Coingecko — some of these tokens don’t even have a functioning product!

Instead, what they have is strong marketing or strong community driving the prices up. For example, Dogecoin investors love DOGE because of its memetic nature, and they often spin the perception of DOGE being Elon Musk’s coin.

Dogecoin and Elon Musk

The association of DOGE with Elon Musk in investors’ mind can be a narrative spun by early investors to get more investors to buy the token.

Prices going up with marketing is simple. Good marketing creates attention, attention drives money inflow.

Poor tokenomics and utility

Tokenomics is one of the hardest thing to get right for a project.

When paying out high yields to attract deposits, projects often need to distribute a significant amount of its supply to investors. Obviously, if uncontrolled, the high supply distribution in the market without new demand will only crash the price.

Many projects suffer from poorly designed tokenomics. For example, Ellipsis Finance on Binance Smart Chain did not have a sustainable manner to create demand for its token EPS. Instead, it continuously distributed new supply to both liquidity providers and Curve CRV stakers for a year; creating constant dumping pressure for an entire year.

There’s no reason to hold or stake EPS as well. As users flock away from Binance Smart Chain to lower cost blockchains like Polygon, Ellipsis began losing market share to competitors like Curve on other blockchains.

Projects often create reasons to buy and hold or stake the token. This is the primary form of demand for the token. For example, projects like Curve created a staking contract for holders to stake their tokens for a weekly percentage share of the protocol revenue. This aligns incentives between liquidity providers and token holders.

Curve has also gone many steps further to create demand for its token. For example, it’s often locked for 4 years so that governors can influence where future token supply gets distributed towards. This could mean incentivizing their own newly created stablecoin pool which has bootstrapping benefits. It has also partnerships with protocols like Convex Finance to create further utility for its token.

Overhyped project

The final reason for a fast and furious price crash is often, simply, an overhyped project which did not establish a price floor.

We see this in many recent DeFi 2.0 projects like Olympus DAO and its clones. The price climbed too quickly, fueled by high yields for staking and a memetic (3,3) reason to not sell the tokens.

However, when the market turned around, the price crashed very quickly. (3,3) became (-3,-3) as investors sought to exit as quickly as possible. When prices fell, yields which are priced in the token also fell quickly as well. The downward spiral in prices led to investors questioning their decision to invest in the first place — was it just hype?

Olympus DAO at its peak valuation, was valued at US$2.8T. Today, after the crash, it’s valued at US$456m, and it never recovered to its past glory.

Market capitalization over time of Olympus DAO

There are plenty of other reasons why the prices of tokens can fall — from FUD to liquidation cascades when a whale sells, to poor execution of the team due to missed deadlines and poor product market fit.

When deciding to sell a token during the price decline, it might be good to ask yourself what’s the reason for the price decline. Is it something short-term bearish but long-term bullish? Or is it pure market manipulation where whales are trying to push down prices to buy cheaper?

Could the project turn it around in future with better tokenomics and marketing? Or is this a lost cause?

Understanding the risks of investing in crypto projects is helpful to prevent huge losses in crypto but also capitalize on being early to a price reversal.