There's a bloodbath in cryptocurrencies on May 19. Major cryptocurrencies are down sharply. They are continuing the slide that we’ve seen for most of May. The cryptocurrency bubble seems to have burst. While several factors are at play in the sell-off, Elon Musk’s flip-flops and irrational exuberance among retail investors look like the key culprits. The final nail in the coffin came from China’s ban on cryptocurrencies.
First, there were signs of a bubble in cryptocurrencies. Dogecoin, a cryptocurrency that started as a joke, reached a market capitalization of nearly $100 billion. There was an irrational exuberance towards digital assets and a lot of retail investors joined the party not knowing much about digital assets.
Why China banned cryptocurrencies
China has always been concerned about the stability of the financial system. In 2017, it shut down domestic cryptocurrency exchanges. The country has tightened its previous regulations and barred the country’s financial institutions from providing cryptocurrency-related services. However, it hasn’t barred individuals from holding cryptocurrencies.
China’s financial regulators didn't mince any words in warning investors about cryptocurrencies. “Recently, crypto currency prices have skyrocketed and plummeted, and speculative trading of cryptocurrency has rebounded, seriously infringing on the safety of people’s property and disrupting the normal economic and financial order,” said the regulators in a joint statement.
Bank of England also warned about cryptocurrencies
Andrew Bailey, the governor of the Bank of England, also warned that crypto investors could end up losing all of their money. Warren Buffett and Charlie Munger have been among the prominent critics of cryptocurrencies and the former called Bitcoins a “rat squared poison.” Nouriel Roubini dubbed as “Dr. Doom” is among the staunch critics of cryptocurrencies.
While China has tightened regulations related to cryptocurrency, the country is also testing a digital yuan. Some U.S. companies, including Starbucks, are participating in the program.
While many regulators globally might support blockchain as a concept, they might not be willing to accept the infringement from cryptocurrencies on their turf. The popularity of cryptocurrency comes at the cost of other currencies, which crypto lovers see as “useless fiat currencies.”
At least currencies issued by central banks have backing from a federal government. While many see cryptocurrency as the future and point to the flurry of money printing by central banks, many of the cryptocurrencies also have an unlimited supply.
Even if some cryptocurrencies like Bitcoin have limited supply, they might not be a medium of transaction for most merchants. A “currency” that can go up or fall by double digits on a particular day, which can play havoc with a company’s profitability that accepts them as a mode of payment. The only real use that I see for cryptocurrencies is for paying ransoms, which was likely done in the Colonial Pipeline ransomware attack.
Elon Musk played a part in inflating the bubble.
Musk also played a part in inflating the crypto bubble. From calling himself the “dogefather” one day to terming dogecoin a “hustle” another day, Musk made a joke of a joke coin. He also discovered that Bitcoins aren't environmentally friendly but said that Tesla wouldn't sell the Bitcoins that it holds. However, the company stopped accepting Bitcoins as a payment mode even though Musk held a poll on whether the company should accept Dogecoin.
While commenting on its investment in Bitcoins, Tesla termed them as a safe option and an alternative to holding cash on the balance sheet. It's tough to accept that something like Bitcoin can be an alternative to short-term Treasury bills that companies invest in to park their cash.
Many think that Musk is manipulating the cryptocurrency market. Previously, Musk also threw in his hat in GameStop stock, which was at the forefront in the short squeeze-driven rally.
How the cryptocurrency bubble burst
The huge volatility that cryptocurrencies saw due to Musk’s antics might have made many regulators take notice. China has gone ahead and tightened a ban on cryptocurrencies and more regulators might follow suit. No central bank might be comfortable with an asset that can rise or fall sharply on a celebrity’s tweets.
India is already said to be contemplating a ban on cryptocurrencies. In the U.S., it might just be a matter of time before the watchdogs take a more nuanced view of cryptocurrencies that undermine the U.S. dollar.
Should you buy the dip in cryptocurrencies?
If you are a cryptocurrency fan, you might be tempted to buy the dip in digital assets. However, five years down the line, it won't be surprising if many of the high-flying crypto assets go into oblivion. We saw something similar in the dot-com bust as most companies went out of business even as a tiny fraction like Amazon emerged as winners.