All hype and hot air: The digital currency bubble may be bursting

Has the cryptocurrency bubble burst? That is the question cryptocurrency aficionados should be asking themselves Wednesday, for the recent sharp plunge in cryptocurrency prices is signaling that the crypto party may be over. 

Some might argue that fears about government regulation of cryptocurrencies are depressing their prices, but in my opinion, those prices are dropping because of market fundamentals.

Cryptocurrency investors who have purchased cryptocurrency coins in recent months in the expectation of never-ending price appreciation have suffered substantial price depreciation in recent weeks. Those who borrowed to buy coins may have lost their entire investment.

{mosads}Even those who purchased bitcoins two months ago, when the closing price on Nov. 17 was $7,709, could suffer a loss, given how fast bitcoin’s price has cratered: Its price dropped from $17,527 on Jan.6 to $10,587 at 3 p.m. EST on Wednesday, a decline of 43 percent.

Who knows where bitcoin will bottom out, but it could be much lower than its current price.

Ripple’s XRP, which just a few days ago had the second-highest market capitalization, has lost over three-fourths of its market value since peaking at $3.84 on Jan. 4. By 3 p.m. on Wednesday, XRP had sunk to $1.08, a drop of 72 percent.

This crash is across the board, with nearly every cryptocurrency down by more than 10 percent in just the last 24 hours. Losses of 20 percent, 30 percent or more, are not uncommon.

The aggregate amount of loss in the market value of all cryptocurrencies has been astounding. The aggregate market value of cryptocurrencies peaked at approximately $834 billion on Jan. 7. Just 10 days later, at 3 p.m. on Wednesday, that aggregate market value had dropped by 41 percent, to $488 billion, a loss of $346 billion.

Blogger comments in recent days indicate that the cryptocurrency price crash is causing real pain for the many who gambled that cryptocurrency prices would keep spiraling upward and upward. 

College students, for example, are reporting serious losses in funds they needed to pay tuitions that they have gambled away, betting that their favorite cryptocurrency would never lose value. 

It is anyone’s guess how much money has been borrowed on credit cards or through higher home mortgages to foolishly bet on never-ending cryptocurrency price appreciation. These cryptocurrency “investors” may feel especially intense pressure to sell in order to limit their losses. We may even see some cryptocurrency-linked personal bankruptcies.

When the cryptocurrency market will stabilize and then begin to recover, if it ever does, is unknown since there is no link between cryptocurrency values and the real economy. The values of these so-called currencies have been pumped up solely by hype and hot air.

A key reason why cryptocurrency prices could continue plunging is that their price appreciation has been driven by very short-term speculators, as evidenced by an accelerating rate of buying and selling.

For example, since the first of this year, daily trading volume in bitcoin has ranged from 4.35 percent to 9.18 percent of bitcoin’s market capitalization. Weekly turnover, based on a seven-day moving average has been as high as 50 percent. XRP has shown only slightly less turnover, with daily turnover hitting 8.75 percent Tuesday.

As I pointed out in my first op-ed on the bitcoin bubble, there is no “there” there in cryptocurrencies, with the possible exception of some initial coin offerings (ICOs). Bitcoin, XRP, ethereum, cardano, litecoin, etc., have absolutely no intrinsic value or substance. 

The sole reason to invest in cryptocurrencies was the expectation of price appreciation, for they generate no profits or cash flow. Once that expectation of price appreciation disappears, the bubble quickly deflates.

An interesting question about the “mineable” cryptocurrencies, such as bitcoin, ethereum, bitcoin cash and litecoin, is, when will their “miners” abandon that activity as no longer being profitable? Once they are gone, who will perform the “proof of work” or validation activity that is essential to the ongoing functioning of this class of cryptocurrencies?

Cryptocurrencies are facing an existential crisis, in part because they lack any meaningful institutional support. There is little real-world need for them, other than by those unwilling or unable to move money through conventional banking channels. 

Worse, they consume real resources: electricity, computer processors and human labor. They create negative value added. 

Finally, central banks and other government agencies will not save the day by rescuing the cryptocurrency market, as they did for banks and other financial institutions following the 2008 financial crisis.

Absent price appreciation, cryptocurrencies are huge losers. More and more cryptocurrency investors seem to be waking up to that reality. The crash will continue.

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system and the growing federalization of credit risk. Find his other pieces on cryptocurrencies here, here and here.