The best investment in 2017 hasn't been some hot new tech product or marijuana stocks -- it's been cryptocurrencies. Digital currencies such as bitcoin and ethereum have been off to the races since the year began, with bitcoin having rallied more than 300% year to date, and ethereum up by more than 3,600% in just over eight months. By comparison, it's taken the S&P 500 decades to return what ethereum has for its investors in eight and a half months.
Cryptocurrencies go parabolic in 2017
While momentum has obviously played a role in pushing bitcoin and other cryptocurrencies higher (i.e., the "don't miss the boat" mentality), the underlying technology that supports these currencies known as blockchain looks to be the most tangible catalyst in 2017. Blockchain is the digital decentralized ledger that records transactions within a network without the need for a financial intermediary such as a bank. Because blockchain is designed to be something of an open-source platform, it makes altering data within the network extremely difficult, giving blockchain an added level of security that could make it a preferred channel for transactions in the future.
More than 150 organizations are already testing versions of the ethereum's blockchain in the Enterprise Ethereum Alliance, while bitcoin's recent SegWit2x upgrade to its network should boost capacity and transaction settlement times, and lower transaction fees. These upgrades are expected to make bitcoin more attractive to enterprise clients, giving it a shot at competing with ethereum's popular blockchain.
The falling U.S. dollar has also put some pep in the step of cryptocurrencies like bitcoin. A falling dollar often coerces investors to seek the safety of gold as a store of value. However, some pundits have argued that bitcoin has been the more popular safe-haven investment of late. Given that bitcoin has protocols limiting the number of mined coins to 21 million, it's being viewed as a finite resource by investors, and thus a safe-haven asset to store their wealth.
Bitcoin loses 40% of its market cap in two weeks
While the gains have been astronomical for bitcoin and other cryptocurrencies, so has the volatility. Between the middle of July and Sept. 1, bitcoin rallied from less than $2,000 to nearly $5,000 per coin. More recently, in case you've missed it, bitcoin tumbled -- and I do mean tumbled -- $2,000 per coin in a matter of 14 days. Between hitting its all-time high on Sept. 1 through Sept. 15, bitcoin lost just a shade over $2,000 per coin and hit $2,951. Over this two-week period, bitcoin's market cap shrank by $33 billion, and it pushed the aggregate cryptocurrency market cap of more than 900 digital currencies below $100 billion after they touched $161 billion just two weeks prior.
Why the ransacking of bitcoin, you wonder? Much of the recent shellacking had to do with a crackdown on cryptocurrencies in China. Early in September, documents emerged suggesting that companies would be banned from raising money through controversial initial coin offerings (ICOs), which were being linked with a high potential for financial scams. Seven government administrations that included the People's Bank of China were in agreement via the documents released that ICOs were an unauthorized illegal fund raising activity.
Just one week later, The Wall Street Journal reported through anonymous sources that China was planning to shut down domestic bitcoin exchanges in the months to come. Per Bitcoinity.org, three Chinese exchanges made up close to half of the global market share of cryptocurrency trading over the previous 30 days, leading some to believe that if China were to follow through with its threat, it could lead to market disruption and volatility.
For what it's worth, bitcoin and other cryptocurrencies have rebounded significantly from their lows hit on Sept. 15, with bitcoin now valued at nearly $4,100 as of 6 p.m. ET on Sept. 18. That's still nearly $900 lower than where it was valued at the beginning of the month.
Just the beginning of big trouble for bitcoin?
Nevertheless, the rapid and steep correction in bitcoin exposed some of the flaws that are inherent in cryptocurrencies.
For starters, digital currencies are being traded almost entirely be retail investors. Institutional investors have either stuck to the sidelines and avoided taking a stance on cryptocurrencies like bitcoin, or they've been directly barred by their company from trading in bitcoin or other virtual currencies. JPMorgan Chase CEO Jamie Dimon recently commented that he'd fire "in a second" any employee caught trading bitcoin or other digital currencies. This lack of institutional involvement leaves retail investors to dictate the price of bitcoin, which means a heavy dose of emotion-induced volatility.
Another pretty notable issue with bitcoin is that it's traded on multiple exchanges rather than a centralized exchange like stocks are. Not having a central exchange is considered necessary by engineers to reduce the possibility of a cyberattack that could cripple bitcoin, but it also reduces the legitimacy of bitcoin and increases volatility.
We can also add that there's absolutely nothing tangible yet to decipher how much blockchain could really be worth to enterprises. The ethereum blockchain is being tested in small-scale and pilot programs, but there's little guarantee that it or bitcoin have the preferred blockchain that companies want to use. What's more, the barrier to entry in creating digital currencies is relatively low, allowing rival currencies and blockchains to pop up with regularity.
And of course, there are concerns about regulation. I would view regulation as a double-edged sword. An increasing amount of regulation should help validate a virtual currency, but at the cost of making it less of a libertarian's dream currency.
Simply put, this recent volatility suggests that bitcoin's expectations probably won't match reality, which could be dangerous for investors. I've said it before, and I'll say again: caveat emptor.