Galen Stops presents five different (but not mutually exclusive) theories about why the value of cryptocurrencies has continued to decline in 2018.
At the start of 2017, a single bitcoin was valued at less than $1,000, yet by mid-December it had almost hit $20,000. Investors were pouring into the space, Initial Coin Offerings (ICOs) were being launched left, right and centre and – given the limited supply of bitcoins that can ever exist – some market commentators were making wild predictions about how high the value of this asset would ultimately go.
But despite starting the year at around the $15,000 mark, the price of bitcoin has fallen to $6,671 at the time of writing and other major cryptocurrencies have suffered a similar decline. So what went wrong?
Profit & Loss takes a look at five theories regarding the collapse in the value of these cryptoassets, before then cheating and essentially arguing that it was all and none of these factors that is ultimately responsible.
1. The Greater Fool Theory
The greater fool theory basically says that any price can be justified for an asset, no matter how high, as long as there is someone else willing to pay an even higher price.
Bill Gates, the co-founder of Microsoft, made headlines in May when he applied this theory to bitcoin, and indeed it’s understandable why. Much has been made of the fact that bitcoin and other cryptoassets are completely uncorrelated to traditional financial products and therefore can help diversify investors’ portfolios.
However, there is one thing that bitcoin and other cryptocurrencies are very clearly correlated to: Google searches.
Popularity of “Bitcoin” as a Search Term on Google
Source: Google Trends (Numbers represent search interest relative to the highest point on the chart for the given region and time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular).
Price of Bitcoin
Looking at a one year timeline, it’s clear that the popularity of “bitcoin” Google searches mirror the value of the asset itself. With the obvious caveat of recognising that correlation does not necessarily indicate causation, it doesn’t seem unreasonable to infer that the price action and the interest in bitcoin indicated by these Google searches are related. While media articles about the former potentially drove the later, it is entirely possible that it becomes a cyclical pattern as people searching for information about bitcoin found out about its rising price and decided to invest in the hope that it would continue going up, bringing more attention to the rise in value, increasing the interest in this asset, leading to more buying, etc.
Just as this drove the price up last year, it’s possible that the realisation that the market ran out of bigger fools willing to buy at a higher price, precipitating the collapse in the value of bitcoin and other cryptocurrencies that has taken place year.
2. The Derivatives Launch Theory
The fever pitch around crypto trading appeared to reach its zenith in December 2017, around the time that Cboe and then CME launched bitcoin futures contracts. According to CoinDesk, the price of bitcoin hit its peak at $19,343 on December 16 last year, less than a week after the Cboe launched its bitcoin futures and just one day before the CME went live with its own contracts.
Is it a coincidence that the price of bitcoin has been moving pretty much steadily downwards since then? Some think not.
For example, the Federal Reserve of San Francisco published a report in May, How Futures Trading Changed Bitcoin Prices, which drew parallels to the rise and collapse of the home financing market in the 2000s to argue that the advent of bitcoin futures trading pushed the price of the spot market downwards.
Similarly, Shaun Cumby, CIO at 3iQ, an investment fund manager in Canada, says: “One thing to consider is that, up until the bitcoin futures were launched, the crypto market structure was almost purpose built to just keep going up. People couldn’t express a short view on cryptos in an efficient way and this helped the market move higher and higher.”
The logic here being that the futures provided a way for market participants to short the crypto market, which many duly did, and this dragged the overall value of these assets downwards.
Not everyone is buying this explanation though.
“I don’t think it has had an impact because these are derivatives of the spot market, which is where the price is formed,” says Reginald Ringgold, founder of Blockvest, a US cryptocurrency exchange and index fund.
He adds: “If you look at the heavy margin requirements for trading bitcoin derivatives, you realise that most of the people trading the spot market aren’t going to be trading derivatives as well.”
3. The Regulatory Fear Theory
One of the ongoing challenges for firms trading cryptoassets is predicting how these assets will ultimately be viewed and treated by regulators.
This problem is particularly acute in the US, where a myriad of regulatory bodies with overlapping concerns all seem to be claiming that these assets fall within their purview, without actually providing any definitive outlines of what is and isn’t acceptable when it comes to trading them.
The question of what will happen with ICOs is arguably one that has weighed down cryptocurrencies more generally. There was a massive surge in ICO investment in 2017, and to participate in these ICOs investors needed cryptocurrencies.
“There was this ICO frenzy last year, specifically in the US, which saw people clamouring to buy bitcoin and ethereum in order to contribute to these ICOs. You have to remember some of the ICOs launched around May last year were generating not just 10%, 20% or 30% returns, but in some cases as much as 500% return in a matter of months. This drove buyers into a frenzy. And, in the same way as when one house on the block sells for $1 million, every house on the block gets re-priced, when one of these ICOs sells so well, it drives up the demand for others,” explains Cumby.
However, there are concerns in the market that the Securities and Exchange Commission (SEC) is planning a significant crackdown on ICOs which, combined with the fact that some of them appear to be scams or simply worthless, has caused the pace of ICO investment to slow down, and subsequently the purchase of cryptocurrencies has dropped.
In addition, researchers at the University of Austin published a paper in which they suggest that part of the price spike in cryptocurrencies last year could be the result of market manipulation, while Bloomberg reported earlier this year that the Commodity Futures Trading Commission (CFTC) has subpoenaed the crypto exchange Bitfinex, and Tether, the company behind a crypto-token that is linked to the US dollar, in relation to market manipulation concerns.
All of this, says Ringgold, could have the effect of deterring people from buying and holding cryptoassets.
“The regulatory environment does have an impact in terms of people coming in and maybe selling off because they’re concerned that the regulators are going to crack down on the space. It doesn’t cause a collapse in the price, but it does cause a correction because of various investors selling off assets. If you look at the volumes on the major exchanges you can see a correlation with the news reports, it can certainly create some FUD [Fear, Uncertainty, Doubt] amongst market participants,” he comments.
Again, there are reasons to doubt if this concern over the regulatory status of cryptoassets is really the main factor driving their value down.
Kevin Beardsley, managing director at B2C2, a cryptocurrency market making firm, says that although these regulatory concerns might conceivably cause some institutional participants to push into the crypto space less aggressively than previously, in his conversations so far with these institutions this has not been the case.
Focusing in on the retail side of the crypto markets, numerous sources credibly suggest that the average individual speculator is unlikely to be deterred by seemingly esoteric questions such as whether a cryptocurrency like ether is technically a security or not.
4. The Tax Season Theory
One explanation for why the value of cryptoassets has plummeted in 2018 that was doing the rounds recently was that individuals located in the US were trying to offload these assets before they had to complete their yearly tax returns in April.
The essential premise behind this theory is that if the regulatory status of cryptoassets is currently uncertain, their tax status is even more of a mystery. And so, with a whole industry of accountants panicking in the background, people in the US began selling off their crypto assets to simplify their tax returns and avoid any punitive fines or measures from authorities further down the line.
“A lot of people were saying in April that bitcoin was selling off because people needed to sell in order to pay all their taxes. I found that argument to be silly; people who were saying that have a very narrow view, because if you look at how much crypto is traded in the US compared to the world, it’s a very small amount of the overall activity,” says Sean Ristau, director of exchange integration and education at Bcause, which owns a crypto mining facility, a trading platform and a clearing house.
This theory also suffers from the fact that, although the price of cryptos did rebound somewhat in May, this month the prices have slipped back down to where they were when this supposed tax-driven sell-off was occurring in the first quarter of the year.
Price of Bitcoin Over 3 Months
5. The Hacker Theory
In 2018 alone, the exchanges Coincheck, BitGrail, CoinSecure, Coinrail and Bithumb have all been subject to hacks (or, as some claim, inside job thefts), with news reports suggesting that in the region of $750 million in cryptoassets were taken from these platforms.
Given that these exchanges were neither insured nor regulated, like most of the crypto platforms out there in the market today, it’s not hard to imagine that such high profile thefts would make investors think twice before choosing to participate in this market.
And in some cases it is clear to see the impact of the hack on prices of cryptoassets – after the Coinrail hack news broke, the value of bitcoin immediately dropped 8.3%, to what was at the time a new low of $6,651.
Yet ultimately, it’s hard to believe that high-profile hacks are the reason for the prolonged decline in the value of cryptoassets that has occurred this year.
As Beardsley puts it: “I think that when people hear about an exchange getting hacked, some of them will start thinking about pulling out of the market, but I think that if you zoom out a bit, what happens on one particular day doesn’t matter that much in terms of the long-term price.”
There have been numerous hacks prior to 2018 and this doesn’t appear to have impacted the long-term prospects of bitcoin or other cryptoassets, and sometimes the news of these hacks doesn’t even cause much intraday volatility in the price – the bitcoin market reacted to the $31 million Bithumb hack today with little more than a shrug. Thus, it’s hard to attribute the declining price of cryptoassets this year to hacking or theft scandals.
The Growing Pains Theory
Talking to numerous sources about the decline in the value of cryptoassets this year, they are all consistently keen to emphasise one key point: the relative nascency of this market.
“As someone who has traded illiquid markets for over 20 years, I can tell you that this still feels like a very illiquid market. It’s still such a young market and in many ways it reminds me of the CDS market when that was still in its early stages,” says Cumby.
Similarly, Ristau looks to put the change in cryptoasset pricing from 2017 to this year into more historical context.
“What’s happening right now is that technology is changing so fast that I believe humans have a hard time adapting to these changes as they happen. For example, we had the internet revolution in the late ‘90s, a lot of companies started up and lot of them failed; we had the cell phone revolution happen in the late ‘80s/early ‘90s and continue on upward until the late 2000s, when Apple and Samsung and a couple of others commoditised the market. What you’re seeing with crypto is similar. You have these big run-ups and then once they happen, all it takes is the news that bitcoin is up 25%, and then any speculator who has money to risk is going to put money into the market because they’re speculating that maybe it’ll go up another 25%,” he says.
Ristau adds: “To me, what’s happening in the crypto space right now, particularly with regard to bitcoin, is just a normal retracement, and in percentage terms it’s actually smaller than the previous largest retracement, but there are just a lot more people involved in this space and so there are a lot more different opinions out there about the price movement.”
The retracement that Ristau is alluding to here took place between late 2013, when bitcoin went over $1,000 for the first time, to August 2015, by which time it’s value had dropped down to just $225.
Bitcoin Price November 2013 – August 2015
Beardsley also points to the price run-up in 2013 and subsequent decline as a partial explanation for what has happened this year.
“This is similar to what we saw in 2013, when the potential of this market simply got ahead of the reality of what it was at the time. We’re seeing this again now, particularly with ICOs, where the hype has gotten bigger than the reality of where this market is at this moment in time,” he says.
Ultimately, there is no one explanation for why the value of cryptoassets has declined so precipitously in 2018, but rather each of the theories outlined above are, to a degree, accurate but are really symptomatic of the natural growing pains of new, immature and still developing asset class.
Of course, maybe the price decline is simply these assets finding their fair market value?
“To say that this might be a return to fair market value implies that there’s a logic to the price to begin with!” responds Beardsley.