Crypto infection: what it is, how it affects the market and investments

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4 min.

Many people have probably noticed that a fall in Bitcoin often causes a fall in the entire crypto market. This phenomenon is also known as crypto contamination.

What is crypto infection

Crypto infection is a situation whena negative phenomenon associated with one cryptocurrency entails problems for other similar assets. The reason could be anything: a hacker attack, government actions, vulnerabilities in the program code, and so on. In any case, the meaning is the same - the problem of one cryptocurrency causes panic among people, and they begin to sell not only it, but also other coins.

Let’s say that ether is recognized as a security,as US Securities and Exchange Commission (SEC) Chairman Gary Gensler wants. Hypothetically, this could cause crypto infection. How? The SEC's main argument against Ethereum is its transition to Proof-of-Stake (PoS). If we assume that this is the main reason for the decision, then the question arises: why will other staked coins avoid the same recognition? A security and a cryptocurrency are not the same thing. The former is subject to much stricter regulation. Cryptocurrency was generally conceived as an unregulated and decentralized monetary system. Therefore, the decision to declare ether a security will cause discontent among a very wide public and, as a result, a price collapse. Along the chain, a decrease may also occur in the value of other coins on PoS: Solana, Cardano, Avalanche and others.

The scale of the crypto-infection

What scale can crypto infection have? Big, when the entire economy can be affected. Small, when problems affect certain groups of people.

Let's say some stablecoin has lost its pegto the dollar (or any other asset). This may cause increased investor mistrust. As a result, the entire industry will suffer. Distrust in one stablecoin will lead to the fact that investors may begin to massively get rid of other coins. Multiple requests to exchange stablecoins for other assets will begin. Companies issuing stablecoins will run out of funds, and they will begin to fall one after another. Which, in turn, could lead to losses for banks and companies that accepted payments in stablecoins. This is an example of problems at the macro level.

If problems arise for somea small coin that few have heard of and is used by only a few people for very specific purposes, then the infection will only affect them. As a result, the price of the coin will decrease, and holders will suffer losses. That on the scale of the entire market is just a drop in the ocean. This is an example of crypto infection at the micro level.

The impact of crypto contagion resembles a domino effect. However these are not the same thing. What's the difference?

The difference between crypto infection and the domino effect

Crypto infection, as already writtenabove, is a situation when a negative event affecting one cryptocurrency causes a chain of changes in several others. The domino effect is the same thing, only the reason that causes the movement can be both positive and negative. By and large, crypto infection is a special case of the domino effect.

Let's say in some country there is Bitcoinrecognized as money (for example, in the status of a legal tender). This will have a positive impact on the price of the first cryptocurrency. Trust in BTC will give people confidence, down the chain, throughout the crypto market. Investors will begin to purchase other crypto assets, which will lead to the growth of the industry.

With crypto infection, this is impossible, sincethe cause and outcome must be exclusively negative. In our example, positive news led to a positive outcome—an increase in prices for cryptocurrency.

As a rule, crypto infection is something unexpected. As a result, many investors, holders and businessmen suffer losses. Is it possible to somehow protect yourself from it?

Protection against crypto-infection

Not 100%, of course, but it’s definitely possible to limit risks.

Probably the most banal method of protection forinvestors is asset diversification. These can be different strategies: from Tim Draper’s proposal to invest in at least two cryptocurrencies, to investments in other sectors of the economy, stocks, bonds, real estate, and so on.

Crypto exchanges and mining companiesare required to introduce strict risk management systems. Systems must be built in such a way as to take into account unforeseen situations and deviations. Risk management should become an everyday routine, and not come up only in problematic situations. He is precisely designed to ensure that situations do not arise.

Seems like a good option for tradersstudying the news background on the market as a whole and on individual cryptocurrencies. And it’s also good for them to conduct their own risk management. For example, use stop orders to limit losses.

Banking structures can implement strictKYC (“know your customer”) policy and anti-money laundering (Anti-Money laundering, AML). They should also take care of a sufficient amount of reserves. True, such players have a centralized management model, which goes against the conceptual basis of cryptocurrencies, so there are other negative effects from such procedures.

In other words, crypto infection is a phenomenon in whichone negative event for the crypto industry leads to a whole series of others associated with the fall of the market. In order to fight infection, the principles of diversification and risk management cannot be neglected.