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Our Primer to Preparing for a Crypto Crash

Luna Terra Crypto Crash: What Investors Need to Know

Luna Terra crypto crash. Why did crypto crash today? Do these things to be ready before the next cryptocurrency crash.

As a crypto investor, the May 2022 crash of the Luna Terra crypto crash has shaken many investors.  Many have come to believe that crypto currencies were: 

  • Hedge against inflation -- NOT
  • Digital Gold -- NOT
  • Wrestle control of money away from governments -- NOT

There are several ways to prepare for a market crash. I believe these tips will be useful to avoid the next Luna-Terra crash. I hope you won't ever bet your life savings on any investment and any asset class -- ever. 

What Caused Luna and Terra to Crash?

The dramatic crash of TerraUSD (UST), one of the largest stablecoins, and its sister currency Luna also made matters even worse, experts say. Stablecoins are meant to track the dollar and offer a stable medium of exchange within the crypto markets, so investors don’t have to incur fees by moving U.S. dollars in and out of the market. So, it was a big deal when TerraUSD “de-pegged” from the dollar and crashed to as low as 9 cents.

Unlike the popular stablecoin Tether, it was not backed by cash, treasuries or other traditional assets. Instead, it derived its supposed stability from algorithms that linked its value to Luna. Mr. Kwon, the founder of Terra-UST and Luna, used the two related coins as the basis for more elaborate borrowing and lending projects in the murky world of decentralized finance, or DeFi.

Therefore, when the stable coin Luna crashed, the domino effect caused DeFi to automatically sell the Terra-UST Token. Many traders leveraged their tokens over and over again, which caused a domino effect -- in other words, a spilling over effect.  This caused traders to also sell equities like stocks in order to recover and protect any remaining profits. On May 18, 2022, the stock market had the worst closing since the start of the pandemic in 2020. The down was down 1,100 points on the day. 

 

 

 

Bloomberg: Product Tracking Luna Cryptocurrency Tumbles 99%

 

 

Here are four of them:

 

Luna Terra crypto crash and things to do do now to avoid cryptocurrency crash

 

Only invest money you can afford to lose

What makes an investor different from a gambler or a market trader is long time horizons. If you’re going to need the initial capital within one year, you should not be investing.  If it’s capital that you need to pay daily living, you should not be investing.  If you can’t afford to lose any capital, you should not be investing.  If you lose sleep because you investments are down 15%, you should not be investing.  

When you see your friend or read articles where someone has made 5000% in one year buying cryptos or made 400% on Tesla, envy and greed can get a carried away.  Remember that these people made it because they did and sacrificed many things that you may not have done: 

  1. Have pulled forward their future spending from today: meaning that they didn’t go out to any fancy dinner or bought any fancy clothes. 
  2. Were willing to invests in an idea that they truly believed in it: Green tidal wave like in the case of Tesla
  3. Have money that they could afford to lose if their investments didn’t work out
  4. Did not stretch their budgets – or borrowed money – to buy cryptocurrency or stocks and the market falls

If you can’t do any of these, you shouldn’t be investing -- you can already avoid a cryptocurrency crash

Invest in cryptocurrencies with long-term potential

The investment approach to cryptocurrency investing can be very different between people.  It all depends on a person’s background.  Some people see it is a new speculative bet on transformative technology.  Some people see it as a fad that will go away.  But if you take the long-term investing approach, you’re more likely to carefully do your due diligence by talking to many people, reading lots and lots about the technology – that’s called research.  A great way to avoid a cryptocurrency crash

By doing your research, you will be more likely to calm yourself when the market drops and do not panic sell when the market crashes.  The reason is that market crashes in the cryptoworld is very, very common.  For example, a 35% haircut is very common. If you’re investing in new tokens and coins other than the two established ones (i.e. Bitcoin and Ethereum), you should know that you’re taking a higher risk than stick with the grandfathers of the cryptoworld.  Again, Research can help identify cryptos with the best chance of long-term survival.

Here are some tips to consider: 

  1. Is the crypto an established one? 
  2. Does it have any utility?
  3. Is the leadership behind it reputable and experienced?
  4. Is it in active development with a vibrant developer community? 

Make sure you have an emergency fund

Having a rainy-day fund is like a financial airbag.  The world is a very uncertain place and you never know when you might need an airbag.  A general rule is if you lose your job, you should have at least 3-6 months of savings to pay for living expenses.  These can be stored in cryptocurrency, cash or short-term deposits. It may seem like a lot but the cost of living is always increasing.  In March 2022, the inflation rate was 5.7% in the Canada and 7% in the US.  The war in Ukraine, caused the price of gas to increase by 40% in just a matter of weeks!  The cost of food increased by 25%.  

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

There’s nothing riskier than putting all your eggs in one basket.  There’s an old Chinese saying that if you put your gold three different holes, it is less likelihood that a robber will come and take it all.  Investing in assets that are not correlated at all, is also a good diversification strategy.  The general rule is to not have more than 2% of your overall investment portfolio in cryptocurrency.  Your investment hypothesis should assume that if crypto goes to zero, can you afford it and not end up on the streets.  Thus, avoiding a cryptocurrency crash. May be that’s a good approach. 

I believe that by following these simple tips, you will avoid investing your life savings on another crypto token like the Luna Terra crash

Make sure that you declare and pay your taxes

When investing in cryptocurrency, a common misconception is that cryptocurrency is a legal way to not pay taxes.  The truth that is becoming clearer as a result of the Ukraine-Russian war is that crypto exchanges and selectively sanction who gets the ability to convert crypt back to FIAT.  Once it’s changed back to FIAT, the bank will be able to report it back to the government. 

As such, it is better to have good records and to pay any taxes due.  

 

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Forte Innovations is back-office firm that provides cryptocurrency and ecommerce accounting, bookkeeping, Controller & CFO consulting services.  We are not a public accounting firm and does not provide services that would require a license to practice public accountancy.