Black swan events in crypto, explained

• A crypto black swan event is a sudden, highly unpredictable event which has enormous (and often negative) consequences for the market.

• Though the expression originated in Roman times, its modern usage typically refers to a theory developed by statistician Nassim Nicholas Taleb.

• Black swan events are not restricted to financial and cryptocurrency markets — they can be observed in society, the environment, technology and a range of other domains.

For centuries, the term “black swan” had been used to describe something that is non-existent, owing to the mistaken belief that such creatures could not be observed in nature. 

Following their discovery in the 17th century, however, the term has since been adapted to refer to unforeseen events. Black swan theory is credited to Nassim Nicholas Taleb, who identifies a Black Swan as an event that meets the following criterion:

• The event is an outlier (nothing in the past could point to its possibility).

• The event has an extreme impact.

• The event is retrospectively rationalized  and “made predictable”.

Commonly cited examples of Black Swans include the COVID-19 pandemic, the 2008 financial crisis, the 9/11 attack or the dot-com bubble in the early noughties.

As touched upon already, Black Swans can occur in any domain — and the crypto market is no exception. 

Crypto Black Swans adhere to the same rules as any Black Swan. They are sudden, unpredictable events with wide-spanning consequences. 

Applying the three factors discussed above, here’s what a Black Swan might look like in the crypto markets:

• Unpredictability:  An unanticipated event such as a major exchange hack, the discovery of a critical flaw in a blockchain project’s code or new restrictive regulations.

• Severe impact: A crypto Black Swan event usually culminates in a dramatic decrease in crypto prices, a sharp reduction in liquidity and the loss of investor confidence.

• Hindsight rationalization: Once the event has occurred, crypto analysts and influential figures may attempt to explain its causes, often framing it as something that could have been foreseen with the right knowledge or analysis.

The interconnectedness of cryptocurrency platforms and protocols leaves the market highly vulnerable to systemic disruptions. A single hack or the collapse of a major platform can swiftly trigger a domino effect, cascading into a market-wide crisis that negatively impacts digital asset prices across the board.

The events listed  below are widely cited as some of the crypto industry’s most infamous Black Swan events:

Launched in 2010, Mt. Gox was the leading Bitcoin exchange of its time. In 2014, it accounted for over 70% of total Bitcoin trading volume. However, its subsequent bankruptcy revealed that it had lost hundreds of thousands of bitcoins due to long-term draining of its hot wallet by malicious actors.

Given the relatively small size of the crypto markets at this time, the impact of Mt. Gox’s collapse had widespread consequences on the entire crypto landscape, causing a market-wide crash and shattering trust in centralized exchanges.

The impact of the coronavirus pandemic was felt across industries and societies worldwide. Unsurprisingly, crypto, too, felt its negative consequences, experiencing a 50% dip on Bitcoin in a single day (and a subsequent 40% decrease to the total crypto market cap).

Once a lauded example of an algorithmic stablecoin, TerraUSD lost its USD peg in 2022 during a wider market crash, erasing over $40 billion in value within the week. 

Due to its central role within the ecosystem, the domino effect caused turmoil across a number of protocols and businesses — with a number of high-profile companies (such as Voyager, Celsius and Three Arrows Capital) declaring bankruptcy as a result. TerraUSD’s collapse has since been identified as a factor in the FTX crisis.

In its three-year run, centralized exchange FTX became the third-largest crypto exchange by volume. Like Mt. Gox, it filed for bankruptcy — though in this case, it was due to large-scale fraud committed by its executives. 

A domino effect ensued, noted by price crashes and further bankruptcy filings for platforms whose funds were stored on FTX. The event also brought a great deal of added regulatory scrutiny to the industry, as well as damaging the public perception of cryptocurrency.

Black Swan events in crypto can typically be attributed to foul play (e.g., hacking, fraud) or wider market events (e.g., the COVID-19 pandemic, regulatory crackdown).

In the examples provided above, we can see the damaging effects of security vulnerabilities (in both smart contracts and traditional infrastructure), particularly in the earlier days of crypto when the market was much smaller. 

High-profile hacks have radically altered the course of the industry, affecting attitudes towards centralized exchanges, self-regulation and the value of rigorous security audits.

A Black Swan event can’t be predicted — but it can be prepared for.

For example, a 100% allocation to cryptocurrencies, NFTs or crypto-based public companies poses significant risk. Diversification into other financial markets may help to mitigate this issue and help to reduce exposure to crypto-specific Black Swans. 

Some traders also keep a significant amount of “dry powder” to one side, meaning cash that can be deployed after a Black Swan event has taken place to take advantage of lower prices.

Additionally, it’s worth considering self-custody for at least a portion of any crypto portfolio: doing so can minimize the impact of exchanges or platforms being compromised and your funds being lost.

For more information, check out our Kraken Learn Center article, What is Crypto Custody?

How an individual approaches a Black Swan event depends largely on their goals as an investor. 

Historically, crypto Black Swans have precipitated multi-year bear markets, in which crypto prices collectively trend downwards.

Attempting to time the market is not advisable — correctly identifying the ‘bottom’ is incredibly unlikely, and could result in further losses and unfavorable positions. Additionally, should a Black Swan event indeed precede a multi-year bear market, it’s possible that currently popular assets may never recover, due to changing narratives and newer technologies emerging.

That’s not to say that savvy investors cannot make good trading decisions following a crash. 

Dollar-cost averaging into crypto assets with strong fundamentals may prove a worthwhile strategy if and when the market recovers, with the added benefit of smoothing out price volatility.

See our complete guide on Dollar-cost averaging crypto to learn more about this trading method.

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