What causes cryptocurrency to drop in price?
12 July 2021
The cryptocurrency market is quite the spectacle, you can make some great gains but also some great loses. So, what’s happening in the crypto space now and what caused the latest crash.
The crypto market correction
If you were to buy Bitcoin during the financial market crash in April 2020, then go on to sell it at its all-time high of US $64,898; your year-on-year return for Bitcoin in that period was approximately 854%.
However, the early 2021 bull run was as spectacular as the phenomenon that came after it — a significant correction. While the worst blue-chip stock crash could dive as deep as 40-50% in April 2020, in contrast, the least severe price drop in crypto was as low as 49% for Bitcoin from the all-time high.
Looking at the list of the top 10 most popular coins by market capitalisation, we had movement of up to -71% with some crypto assets in a very short period of time.
Related article: How to buy Bitcoin in Australia
Why did the crypto market take a turn?
The crypto market is highly accessible as it is decentralised. There are two topics that stand out in the most recent movement. The first is the news cycle. The second is crypto exchanges that offer leveraged trading, which allows a trader to borrow money in order to multiply their earnings and risk.
Stage 1: Market euphoria
There were multiple volleys of crypto “good news” with it being reported that the likes of Tesla, MicroStrategy, and Grayscale Bitcoin Trust had invested heavily in cryptocurrencies, especially Bitcoin. And, with fears of a US dollar inflation, the crypto market gained even more attention and grew exponentially in the number of participants.
Leveraged crypto trading has essentially created a market in which neither investors nor traders know absolutely for sure what the “fundamental” base values of cryptocurrencies are. This is also what allows for the peaks and troughs during market movements compared to traditional assets.
Michael Burry, who made millions from betting against mortgage-backed debts at the height of the financial bubble that burst in 2008, had already warned of an incoming crypto crash. “The problem with crypto, as in most things, is the leverage. If you don’t know how much leverage is in crypto, you don’t know anything about crypto,” he once tweeted.
Stage 2: Growing fear, uncertainty, and doubt (FUD)
A flash crash on Sunday 19 April surprised the Asian market in the morning as Bitcoin’s price plunged by more than 10% in a single hour.
Experts discovered that a regional power outage in northwestern China may have caused several Bitcoin mining rigs in the region to shut down, dropping the hash rate (Bitcoin network’s computational power), causing a slower block time and increasing transaction fees.
Unfortunately, lacking in the fundamental understanding of how the Bitcoin protocol works, many retail traders sell, igniting a chain of panic selling.
Related article: How to buy cryptocurrency in Australia
Stage 3: Continued sell-off and accumulation
As the price recovers timidly, on 12 May, Elon Musk announced that Tesla, the company that had bought $1.5 billion worth of Bitcoin in February, planned to suspend payment in Bitcoin for its vehicles, citing environmental concerns. Again, this caused the price to fall by more than 10%.
More crypto “bad news” in the following week caused leveraged traders to give up their position, as China executed a strategic crackdown on China-based crypto mining facilities.
Despite the negative news, experts believed that the crypto market is experiencing a correction, and is clearing the market of leveraged traders, allowing space for long-term investors to take over.
Will crypto prices recover after the drop?
There is no reason why the crypto market would not recover. Just because leveraged bullish traders are on the losing side, doesn’t mean that cryptocurrencies are going to fade away. While many focus on the negative news, there are positive developments that support cryptocurrencies at the fundamental level.
A bill to make Bitcoin legal tender in El Salvador was proposed by President Nayib Bukele, and was “passed swiftly”, making the country the first ever to adopt Bitcoin as one of its official currencies. Other Latin American countries are rumoured to follow soon, such as Paraguay, Mexico, and Panama.
Independent of market conditions, Bitcoin, Ethereum, and many popular crypto networks are getting upgraded.
After many incremental core updates that fell under the radar of most retail buyers, Bitcoin will undergo a major transformation this November with the Taproot update. Bitcoin transactions will become more private and efficient, and this can possibly pave a way to additional functionalities such as advanced smart contracts.
Ethereum is also progressing slowly to adopt a more energy-efficient Proof of Stake protocol, and is currently testing the effectiveness of sharding, which allows transaction speeds to multiply. Once updates are completed, Ethereum will be known as Ethereum 2.0.
Being the biggest platform for deploying decentralised applications (DApps), Ethereum’s ecosystem is too diverse and expansive to ignore, and could continue to grow greatly in the future.
Will cryptocurrencies ever stablise?
Fluctuating markets are part and parcel of the cryptocurrency ecosystem, creating opportunity on both the up and downside. Looking at the history of Bitcoin, these kinds of events are common, usually resulting in a healthy growth phase within a 1-3 year range. Due to the diversity of crypto markets and the ongoing innovation within fintech, there is never a dull day in the world of blockchain.
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