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Why Did Bitcoin and the Cryptocurrency Market Crash?

May 25, 2021 9:23 AM 4 min read

If your investment portfolio includes cryptocurrencies, the past week must have been painfully punishing.

Virtually all digital tokens tumbled and plummeted as a combination of factors sparked a sell-off. Bitcoin, the oldest and most popular crypto, nosedived from its recent all-time high above $64,000 to settle around $40,000 yesterday, after plunging 14% yesterday and nearly touching $30,000-levels. Its peers including Ethereum and Dogecoin followed suit.

There were two main forces that drove this crypto washout.

One: Elon Musk

It’s not every day that you see crypto enthusiasts cursing Mr. Musk.

The Tesla CEO is usually the one driving up Bitcoin prices with his social media posts. But last Thursday, with one tweet he sent the currency crashing by 17% in an instant. He walked back on an earlier commitment to accept Bitcoin as a payment for Tesla’s electric cars, citing the concerning levels of fossil fuel usage involved in the energy-intensive Bitcoin mining process. He later indicated his support, saying Tesla would hold on to its prop Bitcoin investments. What flip flop!?

Crypto markets were already on edge. Tether, a widely-touted stablecoin with a reputation for being pegged to the Dollar (and ergo, being more “stable”), had just revealed that less than 3% of its coins are actually Dollar-backed. Coupled with Musk’s turnaround, this sparked waves of uncertainty.

Against this backdrop, a grim week for the crypto world began. Bitcoin, Ethereum, BNB and their peers suffered more volatility than usual, largely erasing their recent gains.

Then, Tuesday happened.


Two: The People’s Bank

On May 18th, China's central bank barred financial institutions and payment companies from providing any services related to crypto transactions (services like registration, trading, clearing, settlement etc.).

This was in line with Beijing’s long-held distrust of digital currencies, which it has long regarded as not "real currencies" and “not supported by real value”. In 2017, the Chinese government shut down local cryptocurrency exchanges. Two years later, the central bank blocked access to all domestic and foreign crypto exchanges.

FYI: China’s distrust of digital currencies is limited to private ones. It is about to become the first major economy to launch a state-backed crypto - a digital Yuan. Read about that here.

Tuesday’s development was the match in the powder barrel. Major cryptocurrencies such as Ether crashed by as much as 40% in 24 hours. A stunning $9.13bn of crypto positions were liquidated across exchanges. Bitcoin and Ethereum registered their largest one-day losses since March 2020. Dogecoin lost nearly half of its value.

While many coins’ descent has slowed or halted since then, a lengthy rally has essentially been reversed. But has the bubble burst?


“It’s Temporary, Keep the Faith”

For crypto supporters, while the crash has been painful, they view it as an inevitable correction after a red-hot rally which propelled Bitcoin to hit all-time highs on the back of a 450% jump in just six months.

They argue that crypto needs to be viewed from a broader perspective, beyond the past week's bloodbath. Tech companies and banking institutions (here’s a list) around the world are slowly warming up to digital assets. PayPal has begun allowing users in the US to buy, hold and sell cryptocurrency. JPMorgan, which once called Bitcoin “a fraud”, has opined that the currency could give competition to safe-haven assets like gold. Morgan Stanley has begun offering customers access to Bitcoin funds. Citigroup is planning the same.

Furthermore, Coinbase recently made its Nasdaq debut to much fanfare. Soaring investor demand has also broadened the ways in which you can invest in digital tokens - be it via crypto-linked stocks or crypto ETFs.

This growing normalisation and mainstreaming of crypto, enthusiasts say, will help currencies’ prices stabilise and surge again. Last week was just a forgettable hiccup.


“Flee for Your Lives!”

Skeptics and naysayers have a slightly different take. Just like regulators in China - and many other countries - they view the crypto hype as a scam and digital coins as dangerous speculative assets whose inevitable fall from grace will cost their backers dearly.

This isn’t necessarily alarmism. No number of Bitcoins will be of use to you if Bitcoin is banned. And the general regulatory sentiment towards cryptocurrencies remains critical at best and hostile at worst. For example, India, despite its robust domestic crypto market, might opt for the China route and soon ban all private crypto trading whilst championing a state-backed alternative (unless the new panel thinks otherwise).

Then there are the environmental concerns that Mr. Musk seems to be suddenly distressed about. Blockchain mining comes at a grave environmental cost. Cambridge university’s Bitcoin Electricity Consumption Index suggests that this process consumes 133.68 terawatt hours a year of electricity (an estimate; the true number is likely higher). That puts Bitcoin's consumption at the same level as countries like Sweden and Malaysia. Bitcoin's reputation of being associated with money laundering and black market dealings doesn't help either.


What Next?

All said and done, it’s difficult to predict what awaits crypto investors. The recent rout could just be a minor blip to be followed by yet another impressive rally. Or rising regulatory backlash might be the final nail in the crypto coffin.

With exchanges offering as much as 100x leverage, any slide could get accentuated further with traders closing their positions, pushing prices down even further. As one crypto exchange Asia Pac Head said, “Crypto is still a much ‘wilder West’ than any other asset class where you can trade…”

And when you’re dealing with the wild west, it is an ideal ground to speculate.


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