Crypto Winter: Everything You Need to Know

You have likely heard of the crypto winter. But what exactly does that mean, and what does it mean for your investments and taxes?

Key Takeaways

• A crypto winter has set in for cryptocurrencies, causing significant losses to many investors’ holdings.

• Selling for a loss can result in tax consequences unique to cryptocurrency.

• Investors who believe in the long-term potential of cryptocurrency can still use this downward market movement to lower their tax bill through tax-loss harvesting strategies without the negative impact of the wash sale rule for crypto.

Cryptocurrencies have spent much of the past few years soaring in popularity—largely mimicking skyrocketing cryptocurrency prices. However, both trends rapidly shifted into reverse in 2022, ushering in a so-called “crypto winter” that has investors in digital currencies wondering when the thaw will come, and in many cases, what to do about the crypto losses they’ve piled up.

What is a crypto winter?

A crypto winter, for the record, is a fairly loose term. It’s often used the same way “bear market” refers to a decline in stock values. But unlike bear markets, which have to meet specific parameters to be called that, a crypto winter broadly just means a period of lower cryptocurrency prices.

Just how loose a term? Depending on the media outlet, there have been anywhere between one and five crypto winters since 2014.

Why does crypto winter happen?

One way that crypto winters are similar to bear markets is that many things can trigger them—there’s typically no single reason these downturns occur. While what exactly creates a crypto winter is unknown, two previous events in 2014 and 2018, had very different catalysts.

In February 2014, Mt. Gox—a now-defunct Bitcoin exchange based in Tokyo that at one point was responsible for most of the world’s Bitcoin trades—suddenly halted all Bitcoin withdrawals and eventually shut down trading altogether before filing for bankruptcy. The numerous doubts about the security of the crypto exchanges raised by the incident caused Bitcoin to lose almost 60% of its value in 2014.

The 2018 crypto winter is harder to pin on any one thing. Most crypto investors generally viewed digital currencies as being in a bubble at the start of the year. Bitcoin had shot up by nearly 1,400% in 2017; newer coins, such as Ethereum (ETH) and its more than 10,000% gain, had been even more explosive.

But numerous headlines rattled cryptocurrency prices throughout the year, including the hack of the Japanese crypto market Coincheck, as well as major social media companies banning ads for initial coin offerings (ICOs) amid a slew of related scams. The bubble burst was severe: Bitcoin crashed 70% in 2018 and closed down about 80% from its January 2018 peak. The ETH crypto plunged by more than 80% for the year.

The crypto winter that started in late 2021 has its own unique causes.

What led to the latest crypto winter?

The most cryptocurrency-specific drivers of the current crypto winter have reared their ugly heads since spring 2022. But technically, the downturn dates back to November 2021, with the first few months’ worth of cryptocurrency downside coming alongside a broader slump in stocks.

The bear markets in stocks and cryptocurrencies don’t really appear to line up at first glance: The S&P 500 peaked in early January 2022—roughly two months after most major cryptocurrency prices found a top.

But Bitcoin’s drop in value more so mirrored those of the Nasdaq Composite, which peaked in mid-November 2021. Both reacted poorly to the same driver: high inflation, which many (correctly) predicted would spark a wave of eventual Federal Reserve interest-rate hikes. Bitcoin topped out just before November 10, 2021, briefly nearing the $70,000 level. It closed 2021 more than 30% lower, around $48,000. It was hardly alone.

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If you lost money on cryptocurrency, what can you do now?

Cryptocurrency is a relatively new asset class, first originating from Bitcoin’s initial offering in 2009. The investment category has seen a significant upswing in activity, with individual investors around the world participating in both the movements up—and most recently, down. But just because the market shifts into low gear, that doesn’t mean your money is necessarily lost.

If you invested at a price above where your cryptocurrency now currently trades, you’re in a loss position on paper. Just because your position is worth less than what you paid for it, this doesn’t necessarily mean you’ve lost money as you might not need to sell your cryptocurrency for a loss. If you choose to continue holding your crypto for a longer period of time (something the crypto community colloquially refers to as “HODLing” or “holding on for dear life” during the elevated volatility seen in crypto markets), you don’t face any recognized losses, you just realize them on paper. The story changes if you choose to sell or exchange your cryptocurrency, effectively recognizing a capital loss. This converts a paper loss to a recognized loss, and with it, tax consequences.

Does the crypto winter affect all cryptocurrencies?

The cryptocurrency market‌ has suffered immensely during the current crypto winter. The total crypto market cap peaked at about $2.9 trillion in November 2021, fell to about $2.2 trillion by the start of 2022, and currently sits at around $800 billion—a more than 70% decline in a little more than a year.

It’s not one or two coins holding back the group, either: Each of the top 25 cryptocurrencies is down year-to-date.

But some are a lot better off than others. While Bitcoin is down by nearly two-thirds in 2022, and the Ethereum (ETH) crypto is off just a bit more, several stablecoins have managed to hold their ground. USD Coin (USDC) is essentially flat with a few brief spikes of value throughout the year. Tether (USDT) was in danger of losing its 1-to-1 peg to the U.S. dollar a few times this year but has stabilized and is also flat for the year.

How is crypto taxed?

Cryptocurrency is taxed the same way as other capital investments. That means if you buy, sell or exchange crypto in a taxable account, you'll likely have capital gains or losses come tax time. Depending on how long you held your crypto, your gain will be taxed using one of two different sets of tax rates.

• Short-term capital gains tax rates: If you owned the cryptocurrency for one year or less before spending, selling, or exchanging it, any profits or losses are typically considered short-term. Short-term gains are taxed at your ordinary income rate between 0% and 37% in 2022
• Long-term capital gains tax rates: If you held the cryptocurrency for more than one year, any profits are typically long-term capital gains, subject to long-term capital gains tax rates of 0%, 15%, or 20% for 2022.
• If you have capital losses, they can be used to offset equivalent capital gains or up to $3,000 per year of taxable income with the unused balance rolling forward to offset future capital gains or income.

How the “wash sale rule” works with crypto

When you invest, it’s typical for your investments to go up and down in value as markets move, developments happen, or sentiment changes on a day-to-day basis. If you hold an investment that went down in value, but you still believe it could improve in the long run, you might consider taking advantage of the short-term loss to lower your taxable income this year.

The wash sale rule doesn’t allow you to deduct losses on your tax return when you buy replacement securities within a 30-day period either before or after you sold substantially identical securities. The tax basis of the replacement securities becomes the new cost that is then increased by the disallowed loss.

However, cryptocurrency isn’t treated as a security for tax purposes. Instead, the IRS treats cryptocurrency as property, meaning the wash sale rule doesn’t apply.

Tax-loss harvesting for cryptocurrency

While the wash sale rule keeps investors from harvesting losses on securities like stocks and bonds, the wash sale rule doesn’t apply to crypto because the IRS considers it property rather than a security. As a result, you are free to sell your crypto for less than you paid for it, recognize the loss on your tax return, and repurchase your position without falling subject to the wash sale rule.

TurboTax Tip: You can use capital losses to lower your capital gains from other investments or up to $3,000 of other taxable income per year. If you have capital losses in excess of this amount, you can roll them forward indefinitely, offsetting future gains or up to $3,000 of taxable income per year until you have used all of the losses.

In the world of crypto investing, if you book a loss but still believe that the same crypto asset holds promise in the long term, you can repurchase it at any time, even on the very same day you sell, without being affected by the wash sale rules.

Down, but not out

If you’re a long-term investor who believes in the potential of cryptocurrency, you can take advantage of downward movements in the cryptocurrency market. By using tax-loss harvesting strategies, you can lock in capital losses on any cryptocurrency positions you might hold and then immediately repurchase the crypto assets to reestablish your positions. Because crypto currently avoids the wash sale rule other securities must follow, you can sell and repurchase your crypto immediately and still take a loss on your taxes.

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