The crypto market has been in a bear market for months. The prices of most cryptocurrencies have fallen more than 70% and many market participants have been liquidated. HODL strategies that worked well in the bull market no longer work in the bear market. But then, how can profits be made in a bear market?

Table of Contents

1. Fundamental Analysis
2. What is Dollar-Cost Averaging (DCA)?
3. What is short selling?
4. Liquidity pools & Impermanent loss
5. What is a market maker?
6. How do market makers make profits?
7. Self-Custody due to collapsing central parties
8. Sitting out the bear market
9. Conclusion

Fundamental Analysis

Whereas in the bull market coins like Shiba Uni or SafeMoon can be flipped dozens of times, this is less likely to happen in the bear market. Investors in a bear market tend to be more rational, take less risk and take profits faster than in a bull market. 

Doing fundamental analysis can help determine the underlying value of an asset. Whereas in bull markets a narrative plays a major role in the price, in bear markets it may be more likely to be fundamentals. In our previous blog, we discussed on-chain analysis. This can help determine the fundamentals of certain cryptocurrencies in a bear market. This on-chain analysis can determine what a particular coin is worth or should be worth. In other words, it looks at the underlying value of the coin or network.

What is Dollar-Cost Averaging (DCA)?

Dollar-cost averaging (DCA) is a method of periodically buying coins where you divide the amount of money you want to put in over different periods. Many investors use a dollar-cost averaging method in the bear market to slowly buy back their favorite coins as prices fall. With a DCA strategy, you always buy in small numbers, regardless of the change in price. So, you are not trying to time the market. For instance, you might buy a certain amount every week or every month by default and build up a position this way.

Using a dollar-cost average strategy, you invest in a systematic way. By doing so, you switch off your emotions; a major pitfall for many investors. In addition, you reduce the influence of volatility and bad timing on your investment. With a DCA strategy, you ensure a smaller impact of timing because you buy at multiple moments.

However, it is important to keep in mind that a DCA strategy is no guarantee of success. You may continue to buy a coin weekly or monthly in a bear market to see it not rise again in a bull market. On the other hand, it is important to set a point where you take profits on the coins on which you have applied a DCA strategy when we are in a bull market.

What is short selling?

Short selling or going short is selling a security in the market that a seller does not own. This can be done by borrowing this possession to buy it back later - preferably at a lower price - in the market. So, this way, you can make a profit in the market while the price goes down. The difference between the price at which you sell the coins and at which you buy them back is the profit. Thus, you can make significant profits when the price of a coin goes down. Thus, if the price goes up while you have gone short on the coins, you have to buy back the coins later at a higher price and make a loss.

Although short selling can be a lucrative way to make profits during a bear market, it is also very risky. Whereas when buying coins to make a profit, the profit can be infinite, as the price can always rise infinitely, the opposite is true when going short. Indeed, the price can rise infinitely, and your loss can be a lot more than the amount invested. It is therefore important to realize that going short has a lot of risks. A stop-loss can help mitigate the risk.

Liquidity pools & Impermanent loss

Another way to make returns in a bear market is to provide your coins to liquidity pools (LPs). These operate through automated marker maker (AMM) models. Later in this blog, we will come back to the activities of a normal market maker and how they can make profits in the bear market. 

With an automated market maker, you provide liquidity to the market against which other traders can trade. Uniswap and Pancakeswap are examples of a decentralized exchange that use liquidity pools where people can trade. These pools consist of two assets. Often this is Ethereum or BNB and another coin, USDT for example. The balance between the two coins determines the price. The less there is of a particular coin in a pool, the higher the price will be. By providing your coins to liquidity pools, you can receive a share of the transaction fees paid by traders using the pool. So, this allows you to receive returns, even in a bear market.

However, this also comes with risks. For instance, as we wrote in our CeFi vs DeFi blog, several protocols have been hacked. In these hacks, users lost their money in some cases. Besides the risk of using the protocol, there is the risk of impermanent loss. Impermanent loss can occur when the two assets you provided liquidity for change disproportionately in price compared to each other. As a result, you may end up with fewer coins than you owned when you provided liquidity. So, it is wise to research the possibilities of Impermanent loss (IL) well.

What is a market maker?

A market maker is often a financial institution that adds liquidity to the market by buying and selling securities or cryptocurrencies. Often this is a financial institution such as a bank or hedge fund. They are willing to buy or sell in a market at any time and thus literally 'make' a market. The market maker ensures that there is always a market for others to buy or sell in. Major market makers in the crypto industry include Jump Crypto or Wintermute. Alameda Research was also a big market maker in the crypto industry but shut down after the FTX collapse.

How do market makers make profits?

Market makers make a profit by always cashing in a small fee by the difference between the price of buy orders and sell orders (bid and ask price or bid vs ask). So, they always take a small percentage of profit. This makes them want to trade as much as possible to then make as much profit as possible. This way, market makers can make profits in a market that is not going up or even make profits in a bear market. Since for them, it does not matter which direction the price goes. Although it must be said that most market makers still take a directional risk.

Self-Custody due to collapsing central parties

Despite the fact that it is always important to keep cryptocurrencies in your own wallet, this is extra important in the bear market. Since this bear market just goes to show that many parties have traded in the market with borrowed money (leverage), then liquidate their positions or otherwise run into solvency problems and collapse, it is extra important to keep cryptocurrencies in your own wallet in a bear market. Whereas these problems are often disguised in a bull market as everyone continues to make profits, this can quickly turn around in times of adversity.

Sitting out the bear market

It may be an open door, but sometimes when it comes to financial markets it is better to stay on the sidelines: 'keep the money you won in your pocket and walk out of the casino'. The fact that market opportunities are a lot bigger in the bull market may be obvious. Therefore, it may not be a bad idea to wait until a new bull market arrives and the opportunities are once again up for grabs. Although those who make the most profit in the bull market are of course those who bought in at the lowest point in the bear market. But bear in mind that when a cryptocurrency has fallen by 90%, it can always fall another 90%.

Conclusion

There are several ways to still make returns in a bear market. Through fundamental analysis, you can research a coin in which you would like to apply a dollar-cost averaging strategy. To make extra returns on this coin, there is the possibility of providing liquidity in a liquidity pool. Although this always comes with risks, as does going short in a bear market. Sometimes it may be better to sit on your hands until the new bull market starts.