A Crypto Bear Market May Be Coming. Here Are 3 Things to Do if It Happens.

Pessimism about crypto is starting to take root. The total value of the crypto sector has slipped into a broad downtrend in the weeks following the Oct. 10 flash crash, with the market at a bit above $3.2 trillion after a series of declines. Bitcoin (CRYPTO: BTC), which still accounts for well over half of that total, has dropped sharply from its recent all-time high above $126,000, knocking hundreds of billions off crypto's paper wealth, and falling through the psychologically important $100,000 level with ease on its way to push below $90,000.

Some investors argue that this is already a bear market for crypto, or perhaps even the start of a deep crypto winter. Others think it is just a pause before another leg higher, pointing to highly bullish factors like increasing utilization of crypto by major financial institutions. What investors need right now is a simple playbook for what to do if this slide turns into a genuine bear market, so let's dive in and take a look at three things you should do if it arrives.

Image source: Getty Images.

1. Dial back the altcoins before they do it for you

Altcoins are a spectrum of cryptocurrencies ranging from crypto majors like Ethereum (CRYPTO: ETH) and Solana (CRYPTO: SOL) to meme coins as well as tiny tokens with no real users. And that entire spectrum behaves very differently once optimism evaporates, like it might be right now.

In contrast to Bitcoin's staying power, more than half of all cryptocurrencies have already failed or become inactive -- including, for the record, many coins yours truly thought were going to be clever investments. These are the coins most likely to punish late buyers during a real bear market, and it usually isn't perfectly clear which assets are going to go the way of the dodo, and which are going to survive.

Higher-quality and well-established altcoins like Solana, Ethereum, XRP, and Chainlink could still deserve space in your portfolio, especially if you understand their use cases. But they are almost certainly riskier than Bitcoin if the next leg down is severe, and smaller speculative projects are riskier still.

If a bear market arrives, pause all new purchases of tiny or unproven tokens. Anything with less than $5 billion in market cap is a no-no. It might also make sense to slow down your purchases of the crypto majors if you think that you might need the money within the next five years.

2. Harvest some profits from your winners

It's been said that nobody calls it "panicking" if you're the first person out the door. It's also been said that nobody goes broke from taking profits.

It's true that there is a big difference between panic selling and thoughtful de-risking. One is emotional and usually happens late. The other is planned and usually happens while things still feel OK. So now that there could be a crypto bear market on the way, take the opportunity to take some profits if you have some profits to take.

This doesn't mean abandoning your investment theses about your assets or selling everything you hold. It means acknowledging that rallies do not last forever and that the next truly favorable exit opportunity for part of your position might be several quarters away -- or even longer. Historically, Bitcoin has endured drawdowns in the range of roughly 77% to more than 90% from cycle peaks, taking several years to recover each time.

You aren't trying to time the market here. The objective is to secure a portion of your good performance to tide you over for when times are harder, and to make sure that you have some dry powder on hand to buy the dip if you choose to do so.

3. Commit to your bear market rules before your mood turns

The hardest part of a bear market is watching your account balance shrink and realizing that you do not know what you will do if it keeps happening. That's when even confident investors can get rattled and dump their best ideas at exactly the wrong moment.

You can lower the odds of that happening by making explicit right now your rules and triggers for cutting losses or exiting the market.

Start at the portfolio level. Decide roughly how large a total peak-to-trough drawdown you can tolerate without losing sleep, whether that is 20%, 40%, or something else. The more honest you are with yourself, the more effective this tactic will be.

Eventually, another bull market will roll around -- and if you plan ahead, you and your portfolio will be alive to tell the tale.

Alex Carchidi has positions in Bitcoin, Ethereum, and Solana. The Motley Fool has positions in and recommends Bitcoin, Chainlink, Ethereum, Solana, and XRP. The Motley Fool has a disclosure policy.