What will the next crypto bear market look like?

• The 2017 bear market was a multi-year market-wide downturn
• Forward to 2021 and fundamentals are strong with some undervalued asset groups 
• Investors should expect short market-wide bear-phases and brutal group-wide downturns 
• The crypto market is no longer one cohesive entity. Invest accordingly

Context: the 2017 bear market

Those who have been in crypto for a few years still shudder when they think about the aftermath of the ICO craze. After an incredible run in the second half of November 2017, bitcoin’s price lost 80% within a year. The flash flood of retail money that went in on a get-rich-quick-spree dried up almost as fast as it had arrived. 

Many ICO projects with lofty claims, promising to “Disrupt the X trillion $ ABC industry” lost 90% in the first month and then another 90%. More than a few never made it back from the abyss, as investors pulled the plug and called it quits.

Builders with genuine intentions and good projects faced difficulty with lining up funding rounds. Community-operated cryptocurrencies like Ethereum or bitcoin saw miners leave in droves and network security tank.

The gold-digger mentality of the past year left a disgusting aftertaste and made investors and developers give a wide berth around anything labelled crypto. 

The market stayed depressed for more than a year and only started to pick up again at the end of March 2019. It would take until November 2020 until bitcoin’s price would surpass the peaks of its 2017 bull run.

Bitcoin price during the 2017 bull market and its aftermath. Source: tradingview.com

Why the sad faces?

The main reason for the 2018 crypto market depression is that most projects were vaporware. ICOs raised hundreds of millions with a whitepaper or just a website full of ludicrous claims.

Retail investors were happy to keep pumping bags as long as the number went up but got cold feet as they realised that many teams consisted of a web developer, five marketers, and little else. Distrust and disappointment fed upon each other as cryptocurrencies became notorious for being scams. A look at the total market capitalisation of the crypto market excluding bitcoin shows how severe the 2018 downturn was.

Total crypto market capitalisation excluding bitcoin. Source: coinmarketcap.com

$75m in October 2017 turned into $50m by mid-2018. The market cap before the ICO boom was reached again only in September 2020. Retail investors had bought heavily into an already frothy, overpriced market and got slaughtered as rational expectations returned and market participants saw that the king was without clothes.

Without a crystal ball to predict the future, it is best to look at fundamentals to gauge the stage of the market cycle. While no one can predict the movement of a market, there are clear indicators for caution that investors need to heed.

Fundamental difference

A fundamental approach to valuing the crypto market is complex because cryptocurrencies are more like emerging currencies than growth stocks. Numbrs research has an excellent piece on this.

On-chain analysts like Willy Woo or David Puell use a combination of indicators to get a clearer outlook. 

Bitcoin’s MVRV z-score, developed by Nic Carter et al., was a very accurate indicator for market tops in the past. Currently, at 2.5, this metric is far from market bottoms and nowhere near tops of 6 or above, last seen before the Mai 2021 sell-off, where bitcoin lost 50% of its value. It is also a far cry from the pre-2018 crash peaks of 9.

Bitcoin market value to realised value per standard deviation of market capitalisation. Source: lookintobitcoin.com

Another intriguing piece of data is the amount of funding for blockchain projects. CBInsights reports a 384% increase when comparing the first nine months of 2021 to 2020. Not retail investors, but VCs and other professionals with a longer time horizon fund most projects.

Blockchain funding at record highs in 2021. Source: Twitter

Compared to 2017 ICOs, today’s crypto projects deliver. Decentralised finance now has more than $300bn under management, and projects like SushiSwap or Abracadabra.money have price-to-sales ratios of ten or lower.

Meanwhile, play-to-earn games like Axie Infinity open up whole new economies for thousands of gamers through secondary markets for in-game items and characters.

The fundamental difference between 2017 and 2021 is:

1. Bitcoin’s price is high but not frothy
2. Decentralised finance is still vacuuming up assets.
3. Play to earn seems just to get started
4. VC interest in funding blockchain companies is growing

Total market capitalisation has increased from $750bn at the peak of 2017 to $2.8tn in November 2021. The size of the market points to a different scenario for the “next crypto winter”.

Every man for himself

A closer look at the dynamics of the last year reveals that the “crypto market” doesn’t behave like a singular entity anymore. Compared to the price of ETH, DeFi tokens got pummeled with $SUSHI down -80% while play to earn token $AXS skyrocketed +4242% since the beginning of 2021.

The crypto market has started to differentiate. While tail risks like a Tether implosion or a regulatory crackdown would affect the market as a whole, investors should begin to approach crypto investments like macro or stock. Careful research and evaluation of individual projects is likely to yield better results than blanket purchases of the whole market. 

Bundling assets into groups and purchasing 3-5 top projects is a good way to diversify. If exposure to play to earn games is desired, investors could buy $AXS, $YGG and $GALA. A conviction that DeFi tokens are undervalued could lead to purchasing $SUSHI, $SPELL and $OHM. Specific category indexes like the DeFi Pulse Index or the Metaverse index by IndexCoop allow purchasing of managed groups.

Or take the recent rise of Metaverse coins after Facebook rebranded itself as Meta. Tokens like $SAND outperformed the entire market measured in YTD gains within weeks.

Metaverse Index 3M performance. Source: indexcoop.com

Conclusion – This time it’s different

A 2017 style wipeout of all crypto assets across the board is highly unlikely this time. “History doesn’t repeat itself, but it rhymes”, Mark Twain famously said.

Instead of multi-year downtrends, we will see some group-agnostic bear phases of the whole crypto market with quick recoveries, as investors see that the grass isn’t greener anywhere else. And we’re almost destined to see brutal downdrafts of asset groups as crypto investors take profit and move elsewhere. 

Dips are opportunities to enter into overvalued assets or sectors, as this beautiful research by Galaxy Digital shows.

6M and 12M returns following bitcoin downturns. Source: Galaxy Digital

Buying the dip is not just a slogan in crypto; it makes good investing sense, primarily for drawdowns of -15% to -40%. To conclude: Onwards, to more dips!