Cryptocurrency holders awoke to a brutal discovery yesterday.
The crypto market was crashing, with popular coins such as Bitcoin (BTC -0.20%), Ethereum (ETH -0.08%), and Dogecoin (DOGE -1.10%) all down 34% at one point last morning.
Here are the major reasons for the startling fall.
Image source: Getty Images.
Elon giveth, and Elon taketh away
Bitcoin's price surged earlier this year after Tesla (TSLA 4.96%) CEO Elon Musk announced that the electric-vehicle leader invested $1.5 billion in the cryptocurrency. Soon thereafter, Tesla began allowing its customers to use Bitcoin as a form of payment for vehicle purchases. The crypto market cheered the news.
Crypto bulls expected other companies to follow Tesla's lead and begin to convert some of their cash reserves into Bitcoin. They also hoped more businesses would begin to accept cryptocurrency as payment for their products and services, thereby increasing Bitcoin's utility.
That all changed, however, when Musk surprisingly announced on Twitter that Tesla would no longer accept Bitcoin payments. Musk cited the "rapidly increasing use of fossil fuels for Bitcoin mining" and the resulting negative impact on the environment as reasons for the change. He did, however, say that Tesla did not sell its stake in Bitcoin.
Regardless, the news was a major blow to the narrative that a wave of companies would soon begin to add Bitcoin to their balance sheets and payment platforms. In fact, it may be just the opposite. With ESG (environmental, social, and governance) factors becoming ever more important during a time of climate change, corporate leaders will likely choose to distance themselves from Bitcoin and its negative environmental impact.
China cracks down
While Musk was disappointing Bitcoin bulls, China took action to crush them. On Tuesday, the Chinese government banned the country's financial institutions from providing services related to virtual currencies. This includes trading, storage, insurance, and payment services, among others. China also warned of the many risks of investing in cryptocurrencies, including the ease of price manipulation.
These concerns echoed those voiced by other regulators in recent months. In February, U.S. Treasury Secretary Janet Yellen warned about the risks of Bitcoin, including its transactional inefficiency, high energy usage, and extreme volatility. And in May, Bank of England Governor Andrew Bailey also cautioned investors about the risks of cryptocurrency, going so far as to say, "If consumers invest in these types of product, they should be prepared to lose all their money."
It's true that Bitcoin's decentralized nature makes it somewhat insulated from government intervention. But regulators can certainly make it more difficult to buy and use cryptocurrency by targeting exchanges and other fiat currency on-ramps. And with the prospect of a coordinated crackdown by the world's governments seemingly growing, investors are beginning to price in these additional risks.
Tether is exposed
Stablecoins have grown to be a major part of the crypto universe. They've also become the biggest threat to the industry's survival.
Stablecoins were designed to be an easy way to convert fiat currency -- such as the U.S. dollar or Japanese yen -- into cryptocurrency. Their value is supposed to remain stable, with each individual stablecoin backed by an equal amount of fiat reserves held in bank accounts by the issuer.
That's how it was supposed to work. We now know it doesn't always work that way.
Stablecoin leader Tether (USDT 0.02%) has long claimed that each individual tether was backed 1:1 by traditional currencies. It later admitted to tethers being only 74% backed by fiat equivalents.
Things got even worse after Tether was forced to supply more information about its reserves as part of its recent settlement with the New York Attorney General's Office. Tether now says its reserves were less than 10% backed by cash and treasury bills, with roughly half of its reserves comprised of commercial paper from undisclosed companies.
Crypto bulls immediately rushed to praise Tether's newfound "transparency," while skeptics called for increased regulatory oversight of an enterprise that has now issued more than $58 billion worth of its stablecoin into the crypto marketplace.
Tether is operating as a bank without any of the oversight of a bank. And now it has nearly no cash left. When are the regulators going to step in and do something? https://t.co/f77UUtfAo1
— Amy Castor (@ahcastor) May 14, 2021
Why does this matter?
Well, as much as 70% of the trading volume at exchanges is denominated in Tether, by some reports. And researchers have claimed that Tether has been used to support the price of Bitcoin and other cryptocurrencies during market declines.
Bulls say that this is simply how crypto market dynamics work. They argue that more fiat currency floods into the markets when prices fall, which is converted into Tether, which is then used to buy Bitcoin and other cryptocurrencies. Yet skeptics claim that Tether's reserve breakdown and transaction history simply don't support that view. Some even go so far as to claim that Tether is printing tethers out of thin air to manipulate Bitcoin's price.
Whatever side you fall on, one thing is clear. If investors lose confidence in Tether and its price plunges, a significant source of the trading volume in crypto markets could quickly evaporate.
And if it's true that Tether has artificially propped up the prices of many cryptocurrencies -- as a growing number of critics have claimed -- Bitcoin, Ethereum, Dogecoin, and a host of other digital currencies could plunge even further, should Tether collapse.
