Cryptopocalypse Now?

Yes, it’s a dramatic title, but when it comes to the world of cryptocurrencies trading, it must feel quite painful to many to be invested at this time. For many, they will have seen their cryptocurrency holdings decline by more than 30% in the last few days, some much more depending upon when they decided to buy into the rally. And since every major cryptocurrency is losing large amounts of quoted value at the same time, the cycle has increased in severity at each tick down. But how did we get here?

For one thing, it is important to note the impact of margin. For those cryptocurrency exchanges that allow margin trading, some allow the trader to use their open trade equity increases as margin to finance a larger position. While this isn’t a huge concern when trading equities, it is when you consider the extreme volatility of cryptocurrencies. In other words, if a trader has purchased a position and that position were to gain, let’s say, 30% in value, then the trader would be allowed to leverage a larger position by using the unrealized value of the earlier open position to buy more cryptocurrencies. And of course if the new position(s) gain value as well, then this allows for an even bigger position to be margined, and so forth. But if and when the markets take a sharp turn downwards, then traders who have margined their gains on already margined positions must liquidate in order to maintain a market position. But since this pushes the value of their current holdings down, this causes more liquidations. And given how sharply cryptocurrencies can rise or fall, the probability of a cycle of liquidations increases greatly.

This is the feedback loop traders are currently finding themselves in, but without readily available means for most to short sell the market, they are forced to go into cash instead of capitalizing on the decline. As the Chinese government continues to pressure bitcoin miners and South Korea ponders banning cryptocurrency trading, in addition to calls by global central banks for tighter regulation, traders are being forced to consider whether there will be a lot of people willing to buy during such a time of widespread uncertainty. While the future of blockchain itself seems secure, the value of holding particular cryptocurrencies is not. Indeed, many of them are not exactly directly tied to the success of the blockchain protocol they are created upon, leaving open the question of what their value should be based upon. And in the absence of any strong case to establish the value of Bitcoin or Ethereum or any other cryptocurrency besides the price that is currently being traded, it is not surprising that many are convinced it is time to exit and regroup.

Does this mean that cryptocurrencies will disappear? Probably not. They continued to exist after the horrendous collapse of Mt. Gox in 2014, and will likely survive the currently much less severe declines we are now seeing. However, it also seems that the current state of the crypto marketplace will yield much greater regulatory scrutiny and intervention given that there are people who now hold Bitcoin in an IRA or who otherwise are approaching it as an investment. This combined with the introduction of Bitcoin futures products suggests that speculative trading will fall more under the control of governments and central banks. As of the writing of this article on Tuesday afternoon, Bitcoin reached a low of $9928.62 on the GDAX exchange. Given the levels of volatility common in cryptocurrencies, they could be at $15,000 or at $5000 by tomorrow. Until then.