A Crypto Market Crash Is Coming. Here's How to Prepare

Four ways to protect yourself against the next crypto crash.

The cryptocurrency market is notoriously volatile. That can mean drops of more than 50% in a matter of months as well as rapid price gains. After a price spike in November 2021, prices have trended downwards in recent months. It isn't yet clear whether this is part of a bigger crypto market crash. But it's certainly a healthy reminder that crypto prices can go down and investors need to be ready.

As a crypto investor, there are several ways to prepare for a market crash. Here are four of them:

1. Only invest money you can afford to lose

The golden rule of investing in a risky asset class like cryptocurrency is to only invest money you can afford to lose. When you see stories about cryptos that gained over 5,000% in a year, it's easy to get carried away in the hope you can see similar gains. But only a handful of cryptocurrencies produced those returns last year. With over 17,500 cryptos on the market, it takes a lot of luck to pick the ones that will skyrocket. Indeed, given the changing economic environment, there's no guarantee any coins will see similar returns in 2022.

If you stretch your budget -- or borrow money -- to buy a cryptocurrency and the market falls, you could find yourself unable to cover everyday costs like groceries or your accommodation costs. On the other hand, if you only buy crypto with money you can afford to lose, a crash will be disappointing but not devastating. Importantly, you won't be forced to sell at a loss, instead you can hold on and wait for prices to recover.

2. Invest in cryptocurrencies with long-term potential

There are many different attitudes toward cryptocurrency investing. Some people see it as a good short term speculative buy, others want to get in early on what could be a transformative technology. Taking a long term perspective is a great way to guard against panic selling when prices drop. If you plan to hold for the next five to 10 years, you're more likely to research carefully before you buy. And it's easier to see a market crash as part and parcel of crypto's volatility.

Picking cryptocurrencies with long-term potential is not easy. Many promising projects did not survive the great crypto crash of 2018. Some experts say 90% of cryptos would not survive a prolonged crash. Research can help identify cryptos with the best chance of long-term survival.

Here are some factors to look for:

• Is it an established cryptocurrency? It's true smaller cryptocurrencies have a better chance of producing significant gains. But they also carry more risk. In contrast, better-known cryptos like Bitcoin (BTC) and Ethereum (ETH) with higher trading volumes have a better chance of surviving a serious crash.
• Does it have a purpose? Think about what problem the crypto promises to solve, and how many people might benefit from that solution. Look at what its competitors are doing, and how it compares. If the market collapses, coins with no utility are more likely to fail.
• Does it have an experienced and reliable leadership? Management is key to guiding a project through difficult times. Conversely, if a project's leaders are anonymous, it's a big red flag.
• Does it have an active development community? If a project doesn't have many developers working on it, it may already be failing.

3. Make sure you have an emergency fund

Emergency savings are like a financial airbag -- they pop up and cushion you against unexpected disasters. Try to keep three to six months’ worth of living expenses in an easily accessible bank account. It may seem like a lot, but this will tide you through if you lose your job or face another financial crisis. A solid emergency fund can take some of the stress out of a crypto market crash, as it gives you the reassurance to know you can still meet your financial goals. If you don't yet have a well-stocked emergency fund, start putting a small amount aside each month until you do.

4. Make sure cryptocurrency only represents a small percentage of your overall investments

High risk investments like cryptocurrency should only make up a small portion of your total portfolio. There are various ways you can calculate how much you want to allocate, depending on your risk tolerance, your crypto knowledge, and the degree to which you believe crypto could outperform stocks. But the crucial thing is to diversify. If you avoid overexposing yourself to any individual asset class, you'll be able to handle it if one sector -- like crypto -- collapses.

Bottom line

We don't know whether crypto will pick up again in the coming months, or whether this is the start of a longer downturn. Some are already calling it a crypto winter, but it's much too early to say. One big factor is increased regulation, which could have a significant impact on cryptocurrency prices in the short term.

As a crypto investor, the best way to be prepared is to think long term, diversify, and make sure you also have money in other assets. These may include cash holdings, real estate, stocks, and other investments. Cryptocurrency is an exciting asset, but it should never be the only one.