Why have the prices of cryptocurrencies, like Bitcoin, fallen further?
THE PRICE of bitcoin, the world’s most popular cryptocurrency, fell nearly 20% over the weekend, from around $ 57,000 on December 3 to $ 45,000 the next day (it has since partially fallen restored, to approximately $ 49,000). Other popular coins, including Ethereum, lose a similar proportion of their value. The market capitalization of all crypto assets fell from $ 400 billion to $ 2 billion, before increasing slightly. Why have prices gone down and what makes cryptocurrencies so volatile?
In the past, crypto crashes have occurred largely independently of broader market routs. The sharp drop in May, when cryptocurrencies lost 47% of their value in a week, was sparked by a crackdown on crypto-trading in China and a tweet from Elon Musk, the chief executive of Tesla, saying that the electric vehicle maker would stop accepting bitcoin payments. In contrast, the recent drop in crypto prices mirrored that in the US markets, which suffered on December 3 after the last monthly jobs report sent mixed signals about the country’s economic recovery. The unemployment rate fell 0.4 percentage points in November to 4.2%, the lowest since the start of the pandemic. This may have indicated to investors that the Federal Reserve would raise interest rates sooner than expected, thereby reducing returns on riskier assets. Stocks, including those of tech companies, fell. The discovery of Omicron, the new variant of covid-19, on November 24, also increased anxiety in the markets.
The effect of all of this on cryptocurrencies has been particularly pronounced. They are systematically volatile. Although they are billed as digital currencies, their holders treat them not as means of payment but as financial assets. Most are lightly traded relative to stocks, with a few large investors having considerable influence. About 2% of bitcoin accounts hold 95% of the available coins, according to Flipside, a crypto-analysis firm. Last year, less than 20% of the bitcoin supply was actively traded, with most held in long-term accounts. This means that transactions don’t have to be very large to drastically change prices. Crypto exchanges are plentiful: Fragmentation of exchanges increases volatility, as a few exchanges on a given exchange can have a significant effect. Prices are also affected by a massive derivatives market (contracts based on the price of an underlying asset, in this case a cryptocurrency): there are on average five times more bitcoin derivative transactions than of cash transactions of the coin itself. These bets, which are typically made on unregulated offshore exchanges, can change the price of cryptocurrencies, thereby increasing volatility.
As crypto investing gains ground, more established investors are dipping their toes into the market. This could inject more professionalism and make prices less volatile in the long run. But stability is still a long way off. More regulation of crypto is likely, with different countries tightening in different ways. America is considering regulations for stablecoins, a type of crypto that is pegged to a government issued currency; the European Central Bank has approved a framework for oversight of digital payments, including certain cryptocurrencies. And changing interest rate expectations may well continue to drive prices. Investing in crypto is expected to remain a bumpy ride.