Constantinople is under attack; the empire has fallen. Or so we thought. In this article, we explore the different reasons behind the crypto panic and cover why things might not be so bad after all.
Barbarians at the gate
Crypto markets took a beating on Wednesday, as Bitcoin fell by 35%, flirting with the $30,000 barrier, with other cryptocurrencies such as Dogecoin or Ethereum coming off even worse. Across crypto-land, almost $500 billion in market value was vaporized since the peak. The day was “saved” with supporting tweets from Elon Musk and Cathie Wood, bringing prices back off their lows.
As you might guess, there was not only 1 reason for this general scare. Also, there are reasons to think that all is not over.
5 factors explaining the fall
It would be a mistake to think that Wednesday’s fall in cryptocurrency markets was only due to Elon’s tweet. In fact, we have identified 5 factors which contributed to it, among which:
China’s ban on cryptocurrency
Did China just ban crypto? Well, not exactly. While Reuters published a more than dramatic headline stating a complete ban, the real news is a little different. In fact, China’s central bank had simply restated rules limiting crypto transactions, which have been in place since 2017.
Of course, the nuance was lost in the panic, as social media inflamed and reshared the already too dramatic headline of Reuters. A simple reminder transformed into a bomb, which contributed to the general state of panic, and convinced hesitant holders to sell.
Additionally, more doubts and concerns were expressed this month in the US about the regulations of the crypto sector by United States Treasury Secretary Janet Yellen and Securities and Exchange Commission Chair Gary Gensler.
Elon Musk plays with Twitter
Of course, this list without a mention of Tesla’s CEO would be incomplete. His tweets contributed to sending the prices of Dogecoin and Bitcoin up, down, sideways – or wherever he wishes, it seems. After his tweet last week where he implied that Tesla would exit their $1.5 billion bitcoin investment, as well as the announcement that Tesla would not be accepting bitcoin as a payment helped cause a massive sell-off in Bitcoin.
His latest tweet supporting crypto helped stabilizing markets, but also provided an argument for crypto bears who could only point out that the enormous influence of a single Tweeter account on such a broad market was anything but acceptable, let alone safe and sound.
Liquidation of leveraged positions
While this did not cause the panic, it added fuel to the fire. Many individual investors and companies invested in Bitcoin using borrowed money. While everything is fine when the underlying’s price is going up, lending institutions will ask for more collaterals when its price drops. If the borrower cannot satisfy this new requirement, the institutions will liquidate the position to cover their own exposure.
On Wednesday only, over $8 billion-worth of cryptocurrencies were liquidated. This forced selling created a snowball effect, with prices going further down, triggering even more selloffs.
Uncertainty about Tether’s reserves
Tether is a stablecoin, meaning that it is designed to offer a stable value. Pegged to the US dollar, it is a common currency used by traders to go in and out of various other crypto tokens. The issue here was that the company behind the stablecoin refused to prove that Tether was fully backed by a dollar reserve.
The pie chart published last week showed that the company’s reserves were actually backed by commercial papers and various loans, or collateral which would not satisfy the conditions of a regular bank. In face of critics, Tether refused to employ a standard auditor, which brought additional doubts in the mind of investors. According to Caitlin Long, CEO of Avanti Financial, traders have probably been compelled to sell their cryptocurrencies to reduce their risk exposure because of this credit risk. While this issue is not new, the timing could not have been worse, coinciding exactly with days of extreme uncertainty.
Tax Day in the US
Coinciding timing kept coming. May 17th was also the final day to file taxes for Americans. If you had only a glance at crypto markets in the past year, you might guess that traders active in this asset class made some great profits.
Capital gains taxes were owed to the Internal Revenue Service, meaning that it is likely that some investors sold off a portion of their assets to pay their due to the IRS.
Of course, there are many more factors that could come into play, such as the fear of inflation and central banks sticking to loose fiscal and monetary policies. But in any case, these 5 reasons were more than enough to trigger an economic panic and massive crypto selloff.
The end of the siege: everything is not over
While Wednesday might have seemed alarming to most, we first need to acknowledge that this was a massive combination of factors which led the price of bitcoin down to $30,000 and other cryptocurrencies to their lowest levels in months.
If we look at three-months futures contracts in Bitcoin, which usually trade with an annualized premium over the spot price between 8% and 15%, we see that they traded below regular spot exchange prices – which was rather concerning. However, the rate climbed back to a healthy 7%.
The price of bitcoin climbed back to the $40,000 mark on Thursday, thanks to not only Elon Musk’s encouraging tweet and Cathie Wood’s reutterance of her $500,000 target price for bitcoin, but also maybe because of traders acknowledging the factors mentioned above.
In the end, one could argue that the 54% price correction we have seen from the $64,000 all-time was an exaggerated market reaction to speculation, and most likely not to news that would threaten the big picture. Herein lies one of the issues of investing in crypto. The solid fundamentals of blockchain tech is becoming more and more widely acknowledged but without any generally understood way of valuing the tokens, huge price swings are likely to continue.