Bitcoin Price Crashes. Again.

In a dramatic reversal, prices for Bitcoin and other cryptocurrencies crashed earlier this week after several months of new price records. The decline started last week after Tesla chief executive and Bitcoin supporter Elon Musk tweeted that the company was stopping Bitcoin purchases because the cryptocurrency was not environment-friendly.

Even as there was debate between the cryptocurrency’s enthusiasts and critics, traders had already made up their mind. Over the weekend, Bitcoin’s price slid from the $50,000 range and was $42,000 by Monday evening.

But the real problem started two days later.    

What had been a fall on par with the cryptocurrency’s previous price declines turned into a crypto bloodbath amid a frenzied trader selloff on Wednesday. Bitcoin prices and crypto market valuations tumbled. Starting Tuesday evening, in less than 12 hours, Bitcoin’s price collapsed by 26% to $33,681. Crypto market valuations followed suit, plunging by 42.4% to $1.44 trillion.

Why Did Crypto Prices Crash?

It is difficult to pinpoint the exact set of reasons that triggered panic in cryptocurrency markets. Here is a sampling of some of the reasons that reports have mentioned:

Elon Musk: The Tesla cofounder’s tweet about the energy used in Bitcoin mining last Friday seems to have been the catalyst for institutions and traders to offload their positions in the cryptocurrency. They seem to take his tweet as cue that Tesla, one of the biggest corporate investor in Bitcoin, would sell more Bitcoin from its treasury. But he has already allayed those fears.  

China ban: Three agencies in China were reported to have tightened their implementation of a ban on cryptocurrencies, causing a panic selloff. A report this afternoon confirmed the news. It also stated that the State Council’s Financial Stability and Development Committee intends to intensify its crackdown on bitcoin mining and trading. China has already banned Bitcoin exchanges earlier but reports state that its citizens continue to use cryptocurrencies to siphon money across borders.  

Market Action: In rational markets, most traders book profits and exit. The volatile crypto market offers ample opportunities for traders to book short-term profits and recent corporate and institutional investors have taken advantage of the opportunities, sucking out liquidity from it. Tesla was one. Ruffer LLP, a British investment company that made news with its purchase of Bitcoin, offloaded the cryptocurrency in April.

Online publication The Block reports that negative sentiment towards Bitcoin had been building up for some time and traders were looking to sell their positions. “$40,000 is the level they are looking at where we will cut risk and walk away,” a source told the publication. Once the slide began, however, there were few major investors present to halt the dip. According to a Coindesk podcast, 775,000 traders liquidated their positions during the time that Bitcoin price received its pummeling.

So, Which One Is It?  

Any analysis of Bitcoin’s price action is complicated by two factors.

First, the cryptocurrency mostly functions outside modern financial infrastructure. While institutional investors and corporate treasuries have invested in crypto markets, their commitments are still not enough to make a substantial difference to the overall market. For example, the median ticket size in cryptocurrency hedge funds in 2020 was $0.3 million, probably a rounding error for most family offices.

Second, the nascent crypto market is not correlated to broader economic trends. (Or, that is what crypto proponents believe. But there is very little evidence to back this claim). Added to this: Bitcoin’s identity crisis – is it a medium of transaction or a store of value – is still unresolved. A clear investment thesis provides a set of drivers for price action and enables traders to plan their strategy. Last week’s events were an exacerbation of trader fears and demonstrated the control that regulatory agencies still exert on a cryptocurrency that functioned as a rogue currency for several years.

It is probable that price swings in cryptocurrency markets will continue until the time that regulatory authorities bless them with a use case.