Reasons for the collapse of the cryptocurrency: analysis of what happened to bitcoin
Cryptocurrency is volatile, with a track record of “boom and bust“ cycles that have left many wondering whether it’s safe to invest.
The price of bitcoin, the most popular cryptocurrency, dropped below $16,000 in November 2022, a year after it reached a record high of $69,000.
Things have started looking up in 2023 and it’s currently worth around $30,000, but the digital currency was on a downward trajectory throughout 2022. So what fuelled it?What is happening to the value of bitcoin and why?
Bitcoin is incredibly volatile. It is prone to rising and falling sharply on a daily basis. But it’s not the only cryptocurrency to have had a tumultuous time recently.
Global stocks have gone into a downturn as result of:
- The war in Ukraine
- Inflationary fears
- Higher interest rates, which will make it more expensive for businesses to borrow money
This has spilled over into the cryptocurrency market.
The slump in November 2022 was triggered by the collapse of FTX, which handled around $1 billion transactions each day. Its collapse is having a knock-on effect on other crypto exchanges.
In June 2022 bitcoin dropped below $20,000 for the first time since 2020. This was prompted by the decision of Celsius Network, a major US cryptocurrency lending company, to freeze withdrawals and transfers, citing “extreme” conditions.
The move fuelled a slump across the cryptocurrency market.
China’s continued crackdown on crypto is playing a part too.
In addition to this, there have been sudden and severe sell-offs of major cryptocurrencies. This has triggered panic and further sell-offs which has knocked consumer confidence.
But bitcoin has recovered some of the ground it lost last year and is now worth around $30,000.Why is bitcoin so volatile?
Unlike traditional investments such as company shares, where price movements may well be influenced by the performance of the business, bitcoin has no underlying asset.
This means that the movements in its price are based purely on speculation among investors about whether it will rise or fall in future.
As a result, there can be violent swings in the price of bitcoin, even in the space of 24 hours.
At the moment, high inflation and a cost of living crisis are causing people to reduce their investment risk. This has led to people selling their cryptocurrency.
There have also been a number of incidents that have caused the price to fluctuate:
A number of negative stories and threats of further regulation have pushed the price of bitcoin down.
- In November 2022 cryptocurrency exchange FTX went bust after its rival Binance pulled out of a deal to buy it
- In June 2022, Celsius Network, a major US cryptocurrency lending company, froze withdrawals and transfers, citing “extreme” conditions.
- Also in June 2022, Binance, one of the world’s largest cryptocurrency exchanges, paused bitcoin withdrawals, with chief executive Changpeng Zhao blaming a “stuck transaction” that was causing a backlog.
- Early in 2022, it was reported that Russia might ban cryptocurrency operations. But then, after the invasion of Ukraine, there were calls for crypto exchanges to ban Russian transactions.
- In May 2021, Tesla boss Elon Musk said that the electric car maker would no longer be accepting digital payments over concerns about the impact of cryptocurrency “mining” – the computing power required to create the likes of bitcoin – on the environment.
- In June 2021, banks and payment institutions in China were told to stop enabling crypto transactions, and the Chinese government banned the mining of the currencies. Then in September 2021, all crypto transactions were declared illegal, in effect meaning that the likes of bitcoin were banned.
- Also in June 2021, then US president Donald Trump described bitcoin as a “scam” competing against the dollar to be “the currency of the world”.
- FBI agents have seized millions of dollars in bitcoin from criminals down the years.
- In August 2021, UK regulator the Financial Conduct Authority in effect blacklisted Binance, one of the largest crypto exchanges. Big banks such as HSBC and Santander followed suit by blocking customers from making payments to Binance.
- In the same month, the International Monetary Fund issued a warning on countries using cryptocurrencies as legal tender, saying its widespread use would threaten “macroeconomic stability” and could harm financial integrity.
- Crypto heist: last August, a hacker stole $600m in a cyber attack targeting the crypto platform Poly Network, only to return more than half of it four days later saying they did it “for fun” and to “expose the vulnerability” in the system before others did.
But there have been more positive stories and these have given the bitcoin price some protection over the past couple of years:
- In March 2021, Morgan Stanley became the first big US bank to offer wealthier clients access to bitcoin funds – albeit restricted to no more than 2.5% of an investor’s total net worth.
- In June 2021, a month after sparking a crypto sell-off, Elon Musk said Tesla would probably accept bitcoin payments again when more than 50% of its energy usage came from renewable sources.
- Amazon posted a job advert for a “digital currency and blockchain product lead” in July 2021, prompting speculation that it would soon accept bitcoin as payment.
- Last September, El Salvador made bitcoin legal tender
Other stories have been more mixed in terms of what they mean for cryptocurrencies. Among them has been the US Federal Reserve considering whether to launch its own “central bank digital currency” (CBDC).
In March this year, President Joe Biden issued an executive order that aims to co-ordinate the US government’s actions on the regulation of digital assets.
While many crypto fans think regulation is a bad thing, some think this new executive order could help with the development of digital assets, such as the CBDC, to ensure the right consumer protections are in place.Has bitcoin’s bubble burst?
In 2021 the price soared by more than 700% in 12 months to a record high of $69,000 in November.
It certainly seemed like bitcoin’s bubble has burst as investors have lost confidence in the crypto sector. It is uncertainty over the future of bitcoin which caused prices to crash in 2022.
In June 2022, it plummeted below $18,000. It was still below $20,000 by November 2022, just a year after its record high of $69,000.
While it’s now showing signs of recovery, it’s still a long way off from its record highs.
When assets rise very quickly in price and surge to a record high, typically this makes a crash much more likely – or at least a correction, which is when the price falls back down to a more “normal” level.
This appears to be the situation that bitcoin is in right now. It took the cryptocurrency:
- 11 years from launch to get to $20,000 per coin
- But only three weeks for bitcoin’s price to double from there
A decisive year for crypto investors was 2013. Bitcoin’s price went from $13.40 at the start of the year to its height in December of $1,156.10, before falling to about $760 three days later.
Where it is heading next is equally unpredictable.Will bitcoin go back up?
There are no guarantees when it comes to investing, especially with cryptocurrency. As quickly as bitcoin falls, it could just as rapidly climb again.
There are a number of concerns about cryptocurrencies that are dampening its prospects:
- Cryptocurrency exchanges going bust
- Crackdowns in countries like China
- Calls for greater regulation across the globe
- Environmental concerns
- Security issues and hacks
- Their price is based solely on speculation
Further regulation is seen as a threat to the decentralisation of crypto, which is having an impact on the prices of digital currencies.
Bitcoin’s fans point to its positive qualities:
- Transformative technology that could revolutionise industries
- Simpler and cheaper transactions by cutting out “middle men” such as banks
- Easier global trade because, with a non-fiat digital currency, there would be no concerns about exchange rates
- Transactions are more confidential
- It is a safe store of value because it can’t be printed or seized
- Bitcoin has been touted as an alternative to gold, meaning it could prove itself as a hedge against inflation
Given its volatile nature, it is possible that bitcoin will gather momentum again at some point in the future (perhaps weeks, months or even years down the line, or perhaps not at all).
But no one has a crystal ball and the speculative nature of bitcoin makes it difficult to predict.Will bitcoin go up if the stock market crashes?
Not necessarily. Supporters of bitcoin see it as a diversifier in balanced portfolios, but it did no better than stocks at the start of the coronavirus pandemic. This is because investors panic-sold everything.
In the first two weeks of March 2020, bitcoin went down by more than 40%.
“That was when we saw all equity markets take an aggressive leg down because of concerns about Covid-19,” notes Rosie Bullard, partner and portfolio manager at James Hambro & Partners. “So it wasn’t exactly a store of value in an equity market reversal.”
That said, how crypto assets perform during stock market falls will depend on why financial markets have collapsed.
If it was all about an inflationary shock, such as happened in 1974, most bitcoin investors believe it would provide protection.