What is behind the latest plunge in cryptocurrency prices?
The total market capitalization of cryptocurrencies has shrunk by an eye-popping amount of $1.2 trillion in roughly a month and a half after a series of negative catalysts prompted one of the most dramatic bull capitulations the entire space has seen since the 2017-2018 crypto winter.
During this process, the price of Bitcoin (BTC) has nearly halved since its April peak of $64,895 while the price of Ethereum (ETH) has shed almost 60% of its value since the token hit an all-time high of $4,380 back in early May and the negative momentum doesn’t seem to be stopping.
So, what is actually going on? Is this latest downturn in the entire crypto ecosystem pointing to a fundamental flaw in the value proposition of the blockchain or is this a short-lived phenomenon caused by a wave of bad news?
In the following article, we can look at what’s driving the price of cryptocurrencies lower while outlining some plausible scenarios for the future.
China’s crackdown on cryptocurrency mining
This latest meltdown in the price of crypto tokens can be traced back to China’s increasingly hostile attitude toward crypto mining, as authorities have been enforcing different rules that prevent companies from performing this activity.
In March this year, energy authorities from Inner Mongolia, a major mining hub, stated that they will stop crypto mining operations in the region amid efforts to curve energy consumption.
Areas such as Sichuan and Xinjiang, two prominent locations for miners amid their lower energy prices, were among those that suffered from this ban and these measures have prompted companies in the space to seek new horizons to resume operations.
Meanwhile, a joint statement published by three prominent financial associations in the country including the National Internet Finance Association of China (NIFA) effectively banned financial institutions and payment processing services from dealing with digital currencies while also prohibiting the provision of crypto-related services such as transfers, loans, and storage.
Moreover, on 24 May, the Chinese Vice Premier, Liu He, stated that the government aimed “to clamp down on bitcoin mining and trading activity” citing financial stability and environmental concerns as the leading causes for this hostile attitude toward crypto-related activities.
This increased wave of regulatory pressure, which seemingly aims to flush out all crypto-related activity in the Asian country, seems to be aligned with China’s goal of promoting its very own digital currency – the digital yuan.
Multiple investors and institutions have voiced their concerns about the environmental impact that bitcoin mining has amid the elevated levels of energy required to power the devices needed to perform this activity.
A report from the Cambridge Centre for Alternative Finance that tracked energy consumption levels of Bitcoin’s network seems to have triggered most of these concerns as the study compared the amount of electricity required to mine Bitcoin to the annual energy demand of many small to mid-sized countries.
Notably, the research found that Bitcoin mining consumed as much energy as Argentina, Norway, or Ukraine in any given year – a number that surprised many and prompted several hardline speeches against the proof-of-work (PoW) protocol that powers the Bitcoin blockchain.
One of the most interesting developments on this front was Tesla’s decision to stop accepting BTC as a mean of payment for its electric vehicles as its Chief Executive, the controversial Elon Musk, believed that Bitcoin miners must first find eco-friendly ways to perform their activities.
High leverage and other technical factors
An overly leveraged market was also a key driver for the sharp downturn seen in the crypto space, with data pointing to as many as 800,000 crypto traders being fully liquidated as a result of this recent slide. In some cases, overly-exposed leveraged trades reached ratios of 100-to-1.
Extreme leverage often increases the depth of a sell-off as a wave of stop-loss orders is triggered in sequence once the price dives, causing the price of the security involved to move even lower as sellers bid down the price to close their long positions.
According to on-chain data supplier Bybt, over $8 billion in positions were affected by Bitcoin’s May plunge, while exchanges reported strong daily inflows as tokens that were previously in cold storage were moved so they could be ready to be sold.
Although there could be others, the three variables mentioned above are the leading causes for the current weakness in the price of crypto tokens. It is fairly unclear if this downtrend will endure for longer as that will depend on what happens next.
If China continues to enforce further rules banning crypto-related activities, weakness will likely continue as a big portion of the market - around 70% - depends on Chinese participants to provide liquidity.
Moreover, if other countries follow through with these actions or long-term holders become increasingly worried about these threats, chances are that the sell-off could push the price of crypto tokens even lower as sellers will flood the market with coins and they might have a difficult time finding willing buyers in an environment dominated by FUD (fear, uncertainty, and doubt).