Last year, the cryptocurrency market was practically unstoppable. At the beginning of 2017, the combined value of all digital currencies was just $17.7 billion. But by year's end, the more than 1,400 investable cryptocurrencies had an aggregate market cap of $613 billion, representing an increase in value of more than 3,300%. By comparison, the stock market has historically gained 7% a year, inclusive of dividend reinvestment and adjusted for inflation, meaning virtual currencies ran circles around traditional equities.
However, the past few weeks have been a different story. After hitting a peak market cap of $835 billion, the combined value of cryptocurrencies was, at one brief point, cut in half. What's more, the virtual coins that had been leading the charge higher were now the forces dragging the entire market down. And when I say virtual coins, I pretty much mean "bitcoin."
Why bitcoin has lost more than half of its value
In early December, bitcoin nearly hit $20,000 per token. However, as of Feb. 1, 2018, bitcoin had fallen back below the $9,000-per-token mark. This 55% drop in bitcoin -- bitcoin has had more than 20 corrections exceeding a 22% drop since April 2013 -- has erased in the neighborhood of $175 billion in market cap. In fact, Ethereum, the second-largest cryptocurrency by market cap, and the digital currency that yours truly believes should surpass bitcoin, is now within $50 billon of the world's largest cryptocurrency.
What on earth has caused bitcoin to shed $175 billion in market cap in less than two months? It likely boils down to a combination of the following eight factors.
1. South Korea tightens the noose on anonymity
To begin with, South Korea's tighter cryptocurrency controls are spooking bitcoin and virtual currencies as a whole. Beginning on Jan. 30, South Korea is only allowing individuals with verified bank accounts linked to cryptocurrency exchanges to add new funds into digital currencies. Prior to this regulation, users could remain somewhat anonymous, but this move by South Korea guarantees a step up in transparency.
This move is especially noteworthy given that the South Korean won was the second most-used currency in global bitcoin trading behind the U.S. dollar last year. Though South Korean regulators have attempted to reassure investors that it's not trying to suppress cryptocurrency trading or investment, anonymity is one of the many perceived advantages of investing in bitcoin and other virtual coins. With that no longer an option, bitcoin investors are obviously concerned that other countries may follow suit.
2. Facebook pulls the plug on cryptocurrency ads
Just this week, social media giant Facebook (NASDAQ:FB) announced that it was pulling the plug on cryptocurrency and initial coin offering advertisements moving forward. In the words of Rob Leathern, Facebook's product management director, "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."
Facebook has 2.13 billion monthly active users, and its other owned social media sites -- WhatsApp, Instagram, and Facebook Messenger -- rank in the top seven among total users. Cryptocurrencies no longer being able to advertise, or "tell their story," on Facebook are going to lose out on billions of potential impressions. Since word of mouth has played such a key role in pushing valuations higher, this move by Facebook could put a serious damper on bitcoin and the crypto market.
3. Theft is becoming a high-profile issue
Just as news-driven events have been a positive for bitcoin, such as Japan allowing it to be accepted as legal tender last year, news events can also drag bitcoin down. A handful of recent hacking events have shed bad light on the security of blockchain technology.
For instance, crypto-mining service NiceHash announced in December that nearly $70 million worth of bitcoin was stolen, representing one of the largest hauls by cyber thieves in history. Even more recently, hackers absconded with $534 million worth of NEM from Japanese cryptocurrency exchange Coincheck, which surpassed the more than $450 million hack from Mt. Gox that resulted in 850,000 bitcoin being stolen in 2014 as the largest crypto heist ever. Security remains a clear concern for broader crypto adoption.
4. Bitcoin's processing speeds have been bogged down
Bitcoin's blockchain isn't nearly as impressive as it once was. Even though bitcoin essentially brought blockchain into the spotlight, the scaling of bitcoin's network with more and more merchants has left users with a lot to be desired.
According to a transaction speed analysis conducted by HowMuch.net, bitcoin is only capable of processing about seven transactions per second. Comparatively, payment processing giant Visa is capable of processing up to 24,000 transactions per second. With average settlement times that have eclipsed an hour, and average transaction fees that are now north of $28, bitcoin's blockchain luster has faded away.
5. Skeptics can now put their money where their mouth is
Another reason bitcoin has likely taken it on the chin in recent weeks is the ability of skeptics to finally make bets against bitcoin. Whereas the stock market allows investors to make money if an equity moves up or down, cryptocurrency exchange investors traditionally have one means of making money -- the virtual currency has to move higher. There aren't any readily available tools to bet against a virtual token.
However, both the CBOE Global Markets and CME Group kicked off futures trading in bitcoin during December. Futures trading finally allows pessimists to place their bets against bitcoin, thus making money if it falls. Though institutional investors haven't exactly stampeded into futures trading, this persistent drop in bitcoin recently could signal their dollars are beginning to have some influence.
6. Simple profit-taking
We probably shouldn't overlook the obvious, either: profit-taking. Bitcoin rallied from just a fraction of a penny back in March 2010 to almost $20,000 per coin in December 2017. That would have turned a casual $1,000 investment into billions of dollars. Even though bitcoin underperformed its peers on a percentage basis in 2017, it's nearly 1,400% return was still far better than the stock market. It's very possible that some investors locked in their gains and pushed bitcoin lower with their sale orders.
7. The emotional tide has turned
Building off the previous point, don't overlook the role that emotions may have played. Even with institutional investors finally having an avenue to directly impact bitcoin via futures trading, the crypto market still largely belongs to retail investors.
Retail investors have shown, time and again, that they're prone to allowing their emotions to come into play. This can result in overshooting on valuations to the upside and to the downside. It's plausible that retail investors overestimated the adoption of blockchain technology and bitcoin tokens as a means of purchasing goods and services, and now they're paying the price for that overestimation.
8. Traditional equities have been exceptionally strong
Last but not least, traditional equities have been doing really, really well. The S&P 500 gained almost triple its historic average last year, and 10-year Treasury note yields hit a three-year high above 2.7%. This isn't to say that a 2.7% yield is going to attract investors to necessarily abandon their stakes in cryptocurrencies that have gained 1,000% or 10,000%, so much as to point out that avenues to safer and less volatile growth do exist. It wouldn't be in any way surprising if investors were diversifying their assets a bit, with cryptocurrencies like bitcoin being sold in favor of stocks and bonds.