For more than a year now, cryptocurrencies have been the gift that's just kept on giving to investors who've been willing to take the plunge. Sure, digital currencies have hit a bit of a rough patch this month, but they're still up in aggregate market value by well over 2,600% since the beginning of 2017. Comparatively, that return is over 100 times better than the gains achieved by the broad-based S&P 500 over the trailing 13 months.
Why cryptocurrencies have taken flight
What's behind this meteoric rise in cryptocurrencies? It looks to be a multitude of factors, rather than just a single catalyst.
For starters, thank the emergence of blockchain technology, which was brought into the mainstream by bitcoin, the world's most popular cryptocurrency. Blockchain is the digital, distributed, and decentralized ledger underpinning most cryptocurrencies that's responsible for recording all transactions without the need for a financial intermediary.
Its evolution springs from the belief that today's banking system is inefficient. In other words, transaction fees are higher than they should be, and settlement times take way too long. Blockchain resolves these issues by kicking the bank out of the equation, hopefully lowering fees in the process, and by proofing virtual coin transactions in a matter of seconds or minutes. This would make blockchain particularly useful in instances where payments currently take days to settle.
A weaker U.S. dollar has also likely helped push cryptocurrency valuations higher. Though a weaker dollar should help U.S. exports, it devalues the cash holdings of investors. Usually these investors seek a better store of value when the dollar drops, and that go-to asset has historically been gold. Lately, though, with cryptocurrencies soaring, digital currencies have been chosen by some investors as their preferred store of value.
Real-world applications and news-driven partnerships have also played a role in pushing crypto valuations higher. For instance, Ethereum, the second-largest virtual currency by market cap behind bitcoin, has approximately 200 global organizations testing a version of its blockchain technology. Meanwhile, Stellar, a relative unknown a year ago, has emerged from the shadows to secure a partnership with IBM. Stellar's blockchain is being deployed by a dozen South Pacific banks to expedite the settlement of payments made by IBM's customers in the South Pacific. These are just a taste of some of the deals brought about by blockchain.
And, of course, emotions and impressions have played a role. Retail investors have predominantly been in charge of pricing cryptocurrencies, with institutional investors sticking to the sidelines. Word-of-mouth and online impressions continue to be important in drawing in new investment dollars.
Facebook just dropped a potential bombshell on the crypto universe
However, the move higher in cryptocurrencies may be about to hit a snag.
On Tuesday, Jan. 30, social media giant Facebook (NASDAQ:FB) announced that it would be banning cryptocurrency-related advertisements, including bitcoin, along with initial coin offering (ICO) ads (an initial coin offering is like an initial public offering, except for a digital currency). Said Facebook's product management director, Rob Leathern, "We've created a new policy that prohibits ads that promote financial products and services that are frequently associated with misleading or deceptive promotional practices, such as binary options, initial coin offerings and cryptocurrency."
With the implementation of this policy, cryptocurrency and ICO advertisers will lose access to Facebook's leading audience of nearly 2.2 billion users, as well as Instagram's roughly 800 million users. If we were to include WhatsApp and the Facebook Messenger app, too, we're talking about four of the top seven social media properties (all owned Facebook) that won't be advertising cryptocurrencies or ICOs in any form. That's a major blow to the impression and word-of-mouth machine that's kept cryptocurrencies going.
Also noteworthy is the language Leathern used when issuing a statement on the decision. In particular, that ICOs and cryptocurrencies are "frequently associated with misleading or deceptive promotional practices." The move comes just months after China and South Korea banned ICOs with the belief that they were instruments for fraud.
It was only two weeks ago purported crypto Ponzi scheme BitConnect imploded. BitConnect promised outrageous returns of up to 40% a month on money lent in the form of its BitConnect coin (BCC), plus daily interest of up to 0.25% depending on the loan size. The lending and exchange service also had a referral program that provided bonuses. However, the development team abruptly announced roughly two weeks ago that it would be shuttering these services in the wake of bad press, two cease-and-desist letters, and multiple denial-of-service attacks.
The move by Facebook is a reminder that cryptocurrencies are unregulated and in unchartered territory. Investors putting money into digital coins should be prepared for the possibility of losing all of their money given the risks and uncertainties that lie ahead.
Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool owns shares of and recommends Facebook, but has no position in any cryptocurrencies mentioned. The Motley Fool has a disclosure policy.