What Happened? 5 Reasons For Last Week's Crypto Selloff

David Goodboy's picture

Wednesday, February 14, 2018 - 2:30pm

by David Goodboy

They said it could not go down.

In fact, some bitcoin evangelists claimed it was mathematically impossible for the price to drop. Other true believers were calling for $100,000 or even $1 million as the cost of the king of cryptocurrencies spiraled ever higher.

At the same time, the lesser cryptocurrencies were carried along with the bullish fever. Ripple, ethereum, litecoin, and even joke cryptos like Dogecoin rocketed sky-high  as visions of Powerball lottery-like wealth gripped the public's imagination.

During this heady timeframe, the bearish contingent compared the price surge to the Dutch tulip mania of the 1600s and searched for ways to short the monster move. Unlike most other financial markets, there was no direct way to profit from the downside. Sensing the demand, the Chicago Board Options Exchange (CBOE) launched futures in mid- December 2017 to much fanfare among institutions and professional traders. During the same month, Bitcoin and the other cryptos hit their all-time highs.

But after striking a high price just over $19,000, Bitcoin did what was once said to be impossible: it started plunging in value. By December 22, the leading cryptocurrency had lost 1/3 of its value in just five days. January was not kind to the bulls, or HODLers as they like to be called, with another 50% plunge. On February 5, the currency that was impossible to fall hit a low under $6,000, with all other cryptos suffering similar fates.

Over the last several weeks, cryptocurrency has started climbing off the lows, with bitcoin currently trading around $9,000. Other cryptos followed suit, bouncing aggressively from the recent lows. Bitcoin, ethereum, and ripple remain the top three coins in term of market capitalization despite the selling, and it appears prices have stabilized in the most popular names.

What caused the precipitous decline in prices? What, if any lessons, can investors learn from the carnage?

1. Regulatory Scrutiny
The surging prices and popularity of bitcoin has finally attracted government interest. This time, it seems a crackdown in South Korea fueled the selling.

Fawad Razaqzada of Forex.com said, "Cryptos have been held back in recent days amid increasing levels of scrutiny from regulators, most notably in South Korea, where the government is planning to clamp down on trading in virtual currencies."

He added, "The justice ministry is apparently working on a bill to ban cryptocurrency trading through exchanges. If the bill is eventually passed by the National Assembly, it would be terrible news, given that South Korea is the world's third-largest market for cryptocurrencies. The uncertainty is weighing on investor sentiment."

Remember, the central tenant of most cryptocurrencies is decentralization -- meaning the ability to operate without any central authority such as governments or central banks. Word of any government meddling or regulations throws a monkey wrench into the entire original premise of cryptocurrency. In fact, some think that control even causes an existential threat to the currency.

2. Bitcoin Futures
Some experts theorize that it was the launch of bitcoin futures that sparked the selloff. Futures allow traders to leverage up into a position. In other words, a small amount of money can be used to control a significant amount of the underlying asset. The futures provided leverage could allow a small group or a well-heeled individual to directly control the price of bitcoin.

Now, there is not a futures market on the other cryptocurrencies, so what caused them to go down? Well, bitcoin appears to lead the rest of the pack. As bitcoin dropped, the vortex sucked the other cryptos lower. The same phenomenon can be seen in all financial markets.

3. Too Many Other Choices
There are well over 1,000 digital tokens and coins on the market. Many bitcoin owners are diversifying away from the first cryptocurrency in an attempt to catch the next explosive move higher. The shift into a myriad of other choices may have affected price negatively.

4. Plain Old Manipulation/Hackers
It is possible that a small group could be manipulating the price of the cryptocurrency for their benefit. It could be legitimate speculators taking advantage of the newness and unsophisticated nature of crypto exchanges or hackers with malicious intent.

If this is the case, I look at it as growing pains for a new market and nothing more.

5. It's The Way Markets Work
Markets never go straight up. There are always crashes and bull runs in every financial market. After all the overheating in the crypto market, a selloff was not only inevitable, but was healthy for the long-term viability of the products.

This is my number one reason I think the crypto markets sold off. It is merely part and parcel of how markets work.

Risks To Consider: The extreme volatility in cryptocurrency means ultra-high risk. Only invest money you can afford to lose!

Action To Take: Consider placing some risk capital to work in the crypto market at the new lower prices. I am expecting a rebound in the major names to near or above the all-time highs this year!

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.