The news on Wall Street this week has been bleak: sharp declines, fears of a bear market and high-flying technology stocks that suddenly took a tumble.
Traditional stock investors may be taking a beating, but they should be glad they didn’t put their money in cryptocurrencies. As of Wednesday, the price of a bitcoin had fallen about 25 per cent in a week and was down more than 75 per cent from its peak in December.
Other digital tokens have fallen even more sharply in value.
The latest declines are occurring almost a year after cryptocurrency markets, fuelled by a rush of new, wealthy investors, went into overdrive. There are several factors behind the collapse in prices, with many of them the flip side of what drew people to cryptocurrencies in the first place.
RELYING ON UNREGULATED INFRASTRUCTURE AND EXCHANGES IS RISKY.
Most cryptocurrency trading happens outside the United States on exchanges with little or no regulatory oversight. That allowed investors to pile in with abandon, but the inherent dangers have long been clear.
This year, researchers at the University of Texas published evidence suggesting that one of the largest exchanges, Bitfinex, had helped create a proprietary cryptocurrency, tether, that was used to artificially pump up the price of bitcoin and other digital tokens.
Bloomberg reported Tuesday that the U.S. Justice Department was conducting a criminal investigation of price manipulation using tether, one of many issues related to tether that are scaring investors away. Every unit of tether is supposed to be backed by a dollar in a bank, but managers of Bitfinex and tether have struggled to show that they even have bank accounts. Many traders have been selling tether at a loss just so they can take their money out.
The activities of another large exchange, OKEx, have also led traders to question whether they can trust the institutions at the centre of the cryptocurrency industry.
OKEx, which began in China, altered some trading rules without advance notice, according to a large hedge fund, Amber AI, which published a post on Medium about the changes. Amber AI said customers appeared to have lost millions of dollars because of the changes. OKEx, without acknowledging the losses, apologized to customers for some of the changes, which it said had been made to cope with chaotic trading.
REGULATORS ARE CRACKING DOWN.
Much of the excitement surrounding the cryptocurrency markets last year was stirred up by companies that raised money selling custom cryptocurrencies in so-called initial coin offerings, which let start-ups raise money without going through regulators.
At the time, lawyers warned that these offerings would probably run afoul of securities rules. The Securities and Exchange Commission recently stepped up punishment of companies that violated securities law with their offerings. In the most chilling case, the commission punished two companies on Friday for their initial coin offerings, forcing them to return money to investors while saying the cases would be templates for future actions.
CRYPTOCURRENCIES ARE MANAGED BY COMMUNITIES OF DEVELOPERS. THAT CAN GET MESSY.
The bitcoin network was created with open-source software released to the world in January, 2009. For many years, members of the bitcoin community worked together to improve the software. That collegiality has faded. Last year, after a bitter fight, one group released a new version of bitcoin software with slightly different rules that gave rise to a new cryptocurrency, bitcoin cash.
The people backing bitcoin cash subsequently had their own disagreements. This week, they splintered into two groups. In the software world, it’s known as a fork: Bitcoin cash was split into two new cryptocurrencies, Bitcoin ABC and Bitcoin SV.
The new forks have not altered the original bitcoin. But they have created chaos in the trading markets, as exchanges struggle to define which coin customers are trading. The battles have also raised questions about one of the fundamental attractions of cryptocurrencies: their apparent scarcity.
The creator of bitcoin said only 21 million bitcoins would ever be created. But how scarce do those 21 million bitcoins seem if there are also 21 million tokens of each new copycat?
As Naeem Aslam, the chief market analyst at the trading firm ThinkMarkets, put it in a note to clients this week: “Forking has become so common that it puts at risk the notion of limited supply altogether.”
CRYPTOCURRENCIES WERE GOING TO SOLVE ALL KINDS OF REAL-WORLD PROBLEMS. BUT THE REAL WORLD HASN’T HAD MUCH USE FOR CRYPTOCURRENCIES.
Bitcoin was supposed to make it easier to send payments instantly over international borders. Ethereum, the second-largest cryptocurrency network until recently, was going to create a kind of global super computer. Thousands of other tokens were also designed to be used for high-minded purposes. But so far, about the only thing the tokens have been used for is speculative trading.
Developers have complained that bitcoin, ethereum and most other networks are hobbled by technical problems that make their tokens hard to use in real-world transactions. Those working on the cryptocurrencies have promised solutions, but they have been slow to produce them.
GOVERNMENTS COULD GET INTO CRYPTOCURRENCIES, AND DO A BETTER JOB OF MANAGING THEM.
One hopeful sign for digital tokens came from Christine Lagarde, the leader of the International Monetary Fund. In a speech last week, she made a case for why countries and central banks might want to issue digital currencies similar to bitcoin. (Some countries are already experimenting with this.)
But Ms. Lagarde added a note of caution. While saying cryptocurrencies could improve on current payment networks, she also said governments could manage them more effectively and eliminate the issues of trust that have hobbled them. The remarks could have a chilling effect on existing, non-governmental tokens.