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The Reasons Behind the Crashing Crypto Market

Context

Bitcoin and many other cryptocurrencies have been crashing since they hit an all-time high late last year. Bitcoin has lost more than two-thirds of its value since it hit a peak of around $69,000 in November last year and is currently trading at around the $22,000 mark. Ethereum, another cryptocurrency popular among investors, has lost almost 80% from its peak. As a result, the overall market capitalization of cryptocurrencies has dropped under $1 trillion for the first time since January 2021.

Relevance

GS-III: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Dimensions of the Article

  • Why are cryptocurrencies crashing?
  • How do governments view cryptocurrencies?
  • Will cryptocurrencies rise again?
  • End of the road for Cryptocurrencies?

Why are cryptocurrencies crashing?

  • The crash, which shows no signs of reversal yet, seems to have led to a drop in investor enthusiasm with trading volumes in Indian cryptocurrency exchanges dropping by 90% from their peak.
  • In line with the fall in prices of stocks and other assets as central banks such as the U.S. Federal Reserve tightening monetary policy to fight price rise.
  • As central banks withdraw liquidity from the market, there’s less money chasing assets, which in turn causes the prices of assets to drop.
  • crash could also mark the popping of the bubble that has driven the prices of cryptocurrencies to stratospheric levels.
  • price of cryptocurrencies seems driven more by speculative fervour fuelled by easy monetary policy than by any fundamental factors.
  • extreme volatility simply seemed to reflect investor behaviour that bordered on gambling. even though cryptocurrency prices were rising aggressively, the use of cryptocurrencies for real-life transactions was low.
  • there was very little reason to believe that the rally in cryptocurrencies was driven by their wider acceptability as an alternative to fat currencies.

How do governments view cryptocurrencies?

  • even though private cryptocurrencies can rise to the status of alternatives to fat currencies over time, governments and central banks may not allow this to happen.
  • Many countries have taken several steps to discourage the widespread use of cryptocurrencies. While countries such as China and Russia have opted to impose outright bans on cryptocurrencies, others such as India have tried to tax and regulate them heavily.
  • In India, while the government has not imposed an outright ban on cryptocurrencies, the Reserve Bank of India has been quite vocal about the need to ban them completely.
  • It is no surprise that central banks are wary of private cryptocurrencies since they challenge the monopoly that central banks currently enjoy over the money supply of an economy.
  • If cryptocurrencies became widely acceptable, it would affect the control that central banks possess over the economy’s money supply.
  • It would also affect the ability of governments to fund their spending by creating fresh money as citizens could then opt to switch to alternative currencies.

Will cryptocurrencies rise again?

  • Cryptocurrencies such as Bitcoin have always been subject to extreme price swings and that the current crash is a good time to buy these virtual currencies at a tremendous bargain.
  • To be fair, many crypto-enthusiasts have been handsomely rewarded in the past when they bought cryptocurrencies during times of panic selling.
  • They argue that cryptocurrencies, just like gold, protect investors against the risk of price inflation.
  • It should be noted that, unlike fat currencies issued by central banks, the supply of various cryptocurrencies is limited by design.
  • By holding their wealth in cryptocurrencies that either maintain their value or even appreciate in value over time, investors can protect themselves against the debasement of their wealth by central banks.

End of the road for Cryptocurrencies?

  • Many however argue the current crash could very well be the end of the road for cryptocurrencies because cryptocurrencies possess no fundamental value as money.
  • In fact, some have argued that the real value of cryptocurrencies is somewhere close to zero.
  • It should be noted that investors generally believe that the price of an asset gravitates toward its intrinsic or fundamental value in the long run even though it may diverge from its fundamental value in the short term.
  • Crypto-enthusiasts, however, argue that while cryptocurrencies may not be widely accepted as a currency, they still represent an independent asset class like gold that can help investors protect their wealth from central banks.
  • Precious metals such as gold and silver are far more acceptable than cryptocurrencies, which is what gives them their intrinsic value.
  • In fact, precious metals served as currencies for centuries and have been widely used for industrial and other purposes.
  • No cryptocurrency has such a record. The fact that precious metals are limited in supply definitely helped boost their value. But limited supply alone cannot make cryptocurrencies like Bitcoin a valuable asset like gold and silver.

Source – The Hindu


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