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The value of bitcoin, ethereum, ripple, dash and other cryptocurrencies have taken a big hit in 2018
Thursday 01 Feb 2018 Author: Steven Frazer

After rallying through most of 2017, popular cryptocurrencies have firmly fallen out of bed. For example, bitcoin soared to record highs of $20,089 just before Christmas and has since fallen by 44.5% to $11,154.

The decline has been widespread across the cryptocurrency ecosystem with every one of the top 10 cryptocurrencies, by market value, showing steep declines over recent weeks. This group includes ethereum, ripple, dash and others. Although, it is worth noting that ethereum has started to recover quite strongly in recent sessions.

The general decline in the value of cryptocurrencies this year will undoubtedly cement the views of sceptics that the entire industry is nothing more than a financial fad inflated to the extreme, and that the bubble is close to popping.

WHY ARE CRYPTOCURRENCY PRICES FALLING?

It seems investors have been spooked by veiled threats that cryptocurrency markets could face tight regulation down the line, something that could massively undermine the perceived advantages. This could involve bans on underage investors and a clampdown on anonymous trading accounts.

South Korea’s finance minister Kim Dong-yeon recently said that an outright ban on cryptocurrencies remains a possibility; and Chinese authorities are also thought to be mulling potentially restrictive measures.

There were further cautionary words from US Treasury Secretary Steven Mnuchin and UK Chancellor Philip Hammond at the World Economic Forum meeting in Davos last week.

WHAT ARE CRYPTOCURRENCIES?

Bitcoin and other cryptocurrencies are digital alternatives to cash. In theory, they can used to transfer financial resources cheaply and quickly across international borders. In some cases they can be used to purchase goods and services.

They work on what has become known as blockchain technology. A block is a piece of computer code that stores the data for a transaction. It is linked to the existing chain of blocks which acts as a ledger, or a record of all transactions, copies of which are distributed across the entire networks of a cryptocurrency’s users.

WHAT ARE THE CONCERNS?

Unlike traditional currencies such as pounds, dollars or euros, there is no central control of cryptocurrencies, such as the Bank of England in the UK.

That worries politicians, central bankers and many investors. The perceived lack of checks and balances, say critics, potentially opens cryptocurrencies up to be used for all sorts of illegal practices; such as money laundering, organised crime and funding terrorists.

They also potentially loosen the controls governments and central banks have over the traditional cash system.

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GETTING RICH QUICK

Bitcoin and other cryptocurrencies have become notoriously volatile. In the last quarter of 2017 the total market cap of all cryptocurrencies increased by a quarter to around $600bn.

Earlier in January 2018 the total market cap rose to just shy of $830bn, before the big sell-off in the second week of January. It is now trading at around the $570bn mark, but still shows enormous gains over the past 12 months. The market cap was less than $18bn a year ago.

Such vast paper profits have pulled in a lot of new investors, puffing up prices. ‘The key dynamic is that the crypto market is growing by hundreds of thousands of users per week, with the market adding over 100,000 users daily,’ says Jacob Pouncey, a cryptocurrency expert at Saxo Bank.

‘Crypto assets are behaving similar to the dotcom stocks of the late 1990s,’ says Pouncey. He points to examples such as Kodak, the photographic films company; and Long Blockchain – formerly known as Long Island Iced Tea.

‘They have seen their stock prices soar after announcing blockchain pivots, just as did companies that added .com to their names during the internet bubble.’

The analyst also flags the rapid rise of investment vehicles emerging in the cryptocurrency space. By his calculations there are more than 120 crypto-focused hedge funds currently operating, while the US Securities and Exchange Commission has recently noted the increase in the number of blockchain and cryptocurrency ETF applications.

VERY HIGH RISK

What is perhaps most startling about the surging value of cryptocurrencies is that it has not been built on any fundamental change in how they work, or their potential in the long-run.

The ultimate success of any cryptocurrency depends on its ability to become widely accepted and used, so rapid growth in users is a positive sign. Yet even bitcoin, the most popular, remains a long way off mainstream adoption.

Saxo’s Pouncey believes that 2018 could become a make or break year for the cryptocurrency world. Most have progressed little further than producing an idea in a white paper, and a rough technological roadmap. It can be argued that none has as yet made a meaningful demonstration of their fundamental use.

The cryptocurrency space remains in its infancy and that makes it an extremely high risk asset class for investors.

Whether any of these assets will be able to show long-term usefulness remains to be seen, and until there is more positive evidence we firmly suspect that the majority of ordinary investors should avoid the space. We don’t yet know if cryptocurrencies are merely the emperor’s new clothes. (SF)

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