You could accurately say that 2021 was the year of cryptocurrencies. Granted, the biggest and oldest cryptocurrency of all, Bitcoin (CRYPTO:BTC), only rose 60%. Although that sounds like a massive jump compared to major stock market indexes, it didn’t hold a candle to other digital coins.
Ethereum (CRYPTO:ETH), which ranks as the second-biggest cryptocurrency behind only Bitcoin, delivered a return of more than 5x last year. But no coin sizzled as much as Shiba Inu (CRYPTO:SHIB), with its jaw-dropping gain of more than 30,000,000%.
It’s possible that this could be an even better year for these cryptocurrencies. However, don’t bet the farm that will happen. Here’s the single biggest risk for Bitcoin, Ethereum, and Shiba Inu in 2022.
A change in season
In a broad sense, there are two seasons for investing. One is referred to as “risk-on.” During risk-on periods, investors are optimistic about the economic outlook, and political tensions around the world seem manageable. Many investors are comfortable taking on more risk in this environment and tend to buy higher-risk assets, including cryptocurrencies.
The other season is “risk-off.” It’s the exact opposite of the risk-on scenario. The prospects for the economy are more uncertain, and geopolitical tensions heat up. During risk-off periods, investors are much more risk-averse. As a result, they’re more likely to park their money in assets that are perceived to be safer, such as bonds and blue-chip stocks.
Bitcoin, Ethereum, and Shiba Inu face many specific risks that have nothing to do with these two broad seasons for investing. Other cryptocurrencies could steal market share, or glaring security issues could emerge. Ethereum’s big upgrade could run into problems. Elon Musk could channel Warren Buffett and call all digital coins “rat poison squared.”
However, I think that the greatest risk, by far, for Bitcoin, Ethereum, and Shiba Inu (as well as all other cryptocurrencies, for that matter) is a full-blown shift to a risk-off environment. If investors become nervous about taking on significant risk, cryptocurrency prices will tank.
Using history as a guide
Unlike nature’s seasons, the risk-on and risk-off environments don’t occur at regular intervals. For much of the last 10 years, we’ve had a risk-on market. However, there are a couple of times in the relatively recent past that were risk-off periods. History can serve as a guide to give us a feel for just how much these cryptocurrencies might fall in a change of investing season.
You probably won’t be surprised that the coronavirus-fueled market meltdown in early 2020 was a textbook risk-off market. Fear, uncertainty, and doubt reigned supreme at the beginning of the pandemic. Shiba Inu wasn’t around yet, but Bitcoin and Ethereum plunged, along with nearly every other high-risk asset.
Sure, Bitcoin and Ethereum started to rebound quickly after their steep sell-offs. However, it took months to fully recover.
Thankfully, most shifts to a risk-off environment aren’t so traumatic. We saw a lesser transition begin in the latter part of 2021. Again, though, many cryptocurrencies fell quite a bit.
Unfortunately, Shiba Inu wasn’t available to be shown in the above chart. In case you’re curious, though, the token plummeted as much as 68% below its high at one point.
Three things to remember
If there’s a risk-off environment throughout much of 2022, Bitcoin, Ethereum, and Shiba Inu will undoubtedly perform dismally. However, there are three things that I think are important to remember.
First, there’s no way to know for sure in advance what investing season is on the way. In some cases, relatively risky assets can even move higher. Investors sometimes refer to this as “climbing a wall of worry.”
Second, the downturns during risk-off periods are temporary. Some last longer than others, of course.
Third, the underlying strength of any given asset matters. Note that Bitcoin and Ethereum didn’t pull back nearly as much as Shiba Inu did in the final months of 2021. That’s mainly because the two coins are more widely adopted. Lesser-known cryptocurrencies could fall more than Shiba Inu in future risk-off environments.
Knowing these three things can help you make money. Have some cash on the sidelines to put to use in buying the strongest cryptocurrencies when risk-off environments hit with full force. Your returns can be massive when the inevitable rebound comes.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.