Has the bubble burst?

The value of Bitcoin has dropped nearly 40% to what it was nearly a week ago. Has the cryptocurrency finally broken or is it the future of financial transactions?

Background

Cryptocurrencies are entries about token in decentralized consensus-databases. They are called cryptocurrencies because the consensus-keeping process is secured by strong cryptography. Cryptocurrency is an encrypted decentralized digital currency transferred between peers and confirmed in a public ledger via a process known as mining. Below, we take a simplified look at how cryptocurrencies like Bitcoin work.

Bitcoin is a cryptocurrency and worldwide payment system. It is the first decentralized digital currency, as the system works without a central bank or single administrator. The network is peer-to-peer and transactions take place between users directly through the use of cryptography, without an intermediary.

The value of Bitcoins has continued to rise in 2017. Earlier this year, it was worth $1,000 and had risen to over $12,000 by the end of the year. In December, it began to reach dizzying heights when it was valued at just over $20,000.

Analysis

In December 2017, there were two high profile breaches. A South Korean cryptocurrency called Youbit had to declare bankruptcy after it was hacked and 17% of its assets were stolen. In addition, nearly $64m of Bitcoin was stolen by hackers who broke into the Slovenian-based bitcoin mining marketplace NiceHash. These hacks have highlighted concerns about security amid booming trade in Bitcoin and other virtual currencies.

Bitcoin has lost 40% of its value from its peak at the start of this week to around $12,000. Other cryptocurrencies also tumbled: ethereum dropped as much as 36 percent and litecoin slumped as much as 43 percent, according to composite prices on Bloomberg.

Boris Schlossberg, foreign exchange strategist at BK Asset Management said, “Bitcoin as a speculative product has captivated investors this year. The price swings over the last several trading days have proved particularly volatile.  Further downside could impact investor sentiment and physical holdings as traders may liquidate their positions and positions in more traditional markets.”

Michael Novogratz, the former Goldman Sachs Group Inc. and Fortress Investment Group LLC macro trader, has now revealed that he is scrapping all plans to start a cryptocurrency hedge fund. He also noted that the Bitcoin will fall below $8,000. He said, “We didn’t like market conditions and we wanted to re-evaluate what we’re doing.”

The slowdown has resulted in three major cryptocurrency exchanges suspending certain trades. The plunge resulted in a flood of trades that caused a technical slowdown one of Bitcoin's major exchanges, Coinbase. The CME and CBOE exchanges in the US also temporarily suspended trading of certain Bitcoin futures contracts. "This is exactly how this asset trades and has done since the beginning," said Nick Colas, co-founder of New York-based DataTrek Research. "It has a lot of volatility and it will for the foreseeable future."

Charles Hayter, founder and chief executive of industry website Cryptocompare. "A manic upward swing led by the herd will be followed by a downturn as the emotional sentiment changes," he said.

Assessment

Our assessment is that given the fact cryptocurrency exchanges are largely unregulated, extreme rise and fall of their value is to be expected. We believe that volatility will continue to exist in this market despite muted volatility in other capital markets. However, with proper regulation in place, cryptocurrency will become hard money of the future.