Market Corrections vs. Bear Markets in Crypto

Key Takeaways

• A market correction is usually defined as a drop of between 10% to 20%, and can be due to the economy of the asset expanding.

• A bear market is an extensive period of deteriorating asset prices of more than 20%, typically accompanied by widespread negative market sentiments. 

• The major difference between a bear market and a correction is the depth and period of the decline. 

• Markets take less time to recover from corrections and longer periods to recover from bear markets. 

Market corrections and bear markets are terminologies describing periods of price declines in the crypto market, but they are very different. A correction is a sharp but short-term price decline after a recent significant price appreciation, which could happen due to the economy of the asset expanding and investors overbuying the assets and pushing the prices too high. On the other hand, a bear market is an extensive period of declining prices, normally accompanied by widespread negative market sentiments.  

Knowing the difference between a bear market and a market correction can help you better evaluate current market trends and plan your investment strategy based on your risk tolerance level and investment goals.

What Happens During a Market Correction? 

A crypto market correction is a short-lived period of price downturn in response to an overbought or hyped market. When a market declines by around 10% or more from its recent high, it is labeled a market correction. The 10% threshold is not a hard cap; some markets experience corrections of a 3% decline, while others record corrections of up to 20%. However, corrections of 5% to 10% are more common in traditional finance like stocks. 

Unlike corrections in traditional markets, cryptocurrency market corrections are typically more severe. Besides the volatile nature of cryptocurrencies, crypto corrections resemble their traditional finance counterparts. As such, it's common for crypto prices to correct by almost 20%. Generally, alternative coins (altcoins) record sharper corrections versus bitcoin, although bitcoin has experienced multiple sharp corrections throughout its 12-year history.  

Market corrections often happen when the economy is growing or during a bull market. During this time, market participants express overconfidence and spread mostly good vibes, pushing prices to the roof. This sets the stage for a pullback to the average prices, where corrections bring the price levels back down to their realistic values.  

The Frequency of Market Corrections

In traditional finance, corrections typically occur every two years. However, price corrections occur more frequently in the crypto space due to the cryptocurrency market's volatility. There is no definite period for cryptocurrency market corrections  – corrections can take place in days, weeks, or months.

Triggers of a Market Correction

The market can experience a correction without a disastrous event. As you will discover in the list below, some of the triggers of a correction are just related to reduced market participation. 

Low Demand during High Asset Supply

The most popular cause of market corrections is reduced market demand in the face of a high asset supply. Typically, prices can only continue to appreciate when more market participants invest in the asset. When potential investors deem the price overpriced, sell orders exceed the buy orders, leading to a healthy market correction.  

Swing Traders Taking Profits

Swing or day traders are short-term traders who invest in assets to make quick profits. These traders may pressure the price of an asset when they short a substantial amount of their investments. 

High Levels of Leverage Liquidations 

Leverage is borrowing assets from an exchange or lending protocol to boost your trading positions. Since cryptocurrency prices are intrinsically volatile, there are high chances of losing your positions (aka being liquidated) if an asset's price goes against your plans. A widespread liquidation across the market may cause a correction. 

Short-Term Speculative Bubbles

Parabolic short-lived rallies in the crypto space aren't justifiable. Regardless of the potential and fundamentals of a cryptocurrency project, there comes a time when investors want to exit. If a crypto asset's price appreciates significantly and quickly, it will likely experience a correction as investors want to take profits.  

Market Correction vs. Market Crash

Generally, market crashes leave more severe impacts than market corrections. Corrections take a few days to weeks to play out, but crashes normally involves an abrupt drop in the market. Since cryptocurrencies are more volatile, tokens may experience rapid market drops of over 20% during crashes. Moreover, tokens with smaller market caps tend to experience more significant drops than those with larger market caps.  

Crypto crashes tend to be triggered by major news or macroeconomic data. For example, the price of BTC dropped by almost 40% within 24 hours when the World Health Organization (WHO) declared COVID-19 a global pandemic. Another typical example is when BTC crashed from $32 to $0.01 in 2011 after Mt. Gox (the biggest exchange then) hack news.

The market sentiment during a crash is different from that of a correction. On one hand, cryptocurrency investors express much fear and uncertainty during a market crash; however, corrections do not bring widespread panic. While prices may rebound after a crash, severe declines may trigger a bear market – especially drawn out declines of more than 20% that span many months or years.    

What Happens in a Bear Market?

As mentioned, a bear market is an extended period of price downturns; market prices fall by more than 20%. Generally, there is widespread negative market sentiment, accompanied by widespread fear and uncertainty. A bear market resembles a correction – only that it lasts for a prolonged period. Though 20% is the threshold, tokens in bear markets can plunge up to 90% from their recent highs, especially in crypto.  

During this period, the market experiences occasional "relief rallies," but the general trend is deteriorating prices. These markets are characterized by widespread negativity and uncertainty. For instance, terms like "crypto is dead" and "crypto bubble" start to trend on social and mainstream media.  

Ultimately, investors find assets fairly valued and start accumulating, formally ending the bear market.

In a bear market…
know what #cryptocurrency you own and know why you own it!

— CoinGecko (@coingecko) June 28, 2022

In a regular scenario, investors might be bearish on some assets, but this negativity may only affect some markets. However, nearly all assets start declining when the market turns bearish, even if they are broadcasting positive news. Contrary to market corrections that are rampant during times of economic growth or bull markets, sparked by FOMO and overconfidence, bear markets happen during an economic recession or crash. 

What Triggers a Bear Market?

The triggers of a bear market often differ, but generally a slowing economy, inflating market bubbles, global pandemics, wars, geopolitical disasters, and radical paradigm changes in the economy are some major factors that might cause a bear market. The indicators of a deteriorating economy include low employment rates, purchasing power and productivity, and a sharp decline in business profits. Additionally, economic government interventions can activate a bear market.

 For instance, rate hikes can trigger a bear market. Likewise, a decline in investors' confidence may also indicate the beginning of a bear market. When market participants strongly feel something is around the corner, they often choose to be cautious by choosing to exit their positions. This was seen in the events of the FTX collapse, when a surge of customer withdrawals revealed that the company lacked sufficient assets in reserve to meet customer demand. While the downfall of FTX is not the trigger of the current crypto winter, it will could potentially extend the crypto bear market. 

How Long Can a Bear Market Last?

The length of a bear market varies greatly. Some last for a few months, while others take to go for years. For example, there have been 14 bear markets in US stocks since 1947. These bears have been ranging from one month to over a year and a half, with bear markets lasting for an average of 289 days, just over nine months. But there have been some instances where bear markets took much longer. For example, in 2013, the crypto market experienced one of its longest bears, lasting 415 days. 

Bear Market vs. Recession

While a bear market and recession may go hand-in-hand, distinct (albeit related) activities normally trigger them. This is because the stock market and the economy, though often related, are essentially different financial systems. A recession is an economic meltdown often marked by a minimum of two consecutive quarters of deteriorating Gross Domestic Product (GDP). A recession can be triggered by the following:

• A decline in consumer confidence leads to lower spending

• Dismal business performance that causes high retrenchment rates.

• High-interest rates

• Real estate and credit crises

On the other hand, a bear market occurs in the stock and crypto markets. Typically, a bear market begins when declining returns compel investors to exit their investments, causing further pessimism that brings a negative feedback circle. The stock market is often the leading economic indicator, meaning a bear market can indicate an impending recession.

Conclusion

To summarize, here's how market corrections compare to bear markets.

The market tends to recover from corrections faster than bear markets, since the latter usually comes with a longer duration and a larger drop in prices. While it may take multiple months to years for the market to recover, it will eventually recover its previous high. 

Although crypto bear markets and corrections can be scary, they are a normal part of the investing process. Understanding the difference between a bear market and a market correction will help you to navigate the market better and make informed investment decisions.