Breaking down the recent cryptocurrency market dip

The Story

We saw the cryptocurrency market dip from the 16^th April, 2021. The most popular of the pack, bitcoin fell from $63,783 on the 16^th of April 2021 to $47,516 on the 23^rd of April 2021. Its contemporaries (Ethereum, ripple, Litecoin etc.) have all had significant price drop in the past couple of weeks as well.

What exactly is a Cryptocurrency?

Cryptocurrency (Cryptos) is a virtual/digital currency created as a medium of exchange on blockchain technology. It is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows the currencies to exist outside the control of governments and central authorities.

The first blockchain-based cryptocurrency was Bitcoin, which still remains the most popular and most valuable. Today, there are thousands of alternate cryptocurrencies with various functions and specifications. Some of these are clones or forks of Bitcoin, while others are new currencies that were built from scratch.

Let’s Back Track a Bit to See the Price Movement of Cryptos in Time Past

The cryptocurrency market is notorious for wild price swings, the market emerged at the introduction of Bitcoin in 2010, when it traded for less than a dollar, fast forward to 2011, it rallied to $31.90, and then fell back to $4.72 at the close of the year. Its movement remained muted till 2013 when bitcoin price surged from $21 at the beginning of the year, to over a $1,000 towards the end of the year and then fell to about $300 at the beginning of 2014.

As time went by, Bitcoin and other cryptocurrencies gained prominence and its unregulated feature made it attractive to those seeking freedom from the traditional structures of finance and imposters.

2017 was the year of cryptocurrencies. It was the year the crypto market first caught the attention of regulators. The People’s Bank of China (PBoC) and the Securities and Exchange Commission (SEC) in America seeing the growth of the crypto market put in place restrictions on cryptocurrency related transactions.

This drew the attention of the media to the crypto market and created a fuss around cryptocurrencies. As the curiosity around cryptos grew, so did their price.  Bitcoin and its peers were on an upward streak all through the year. Everyone wanted in on cryptocurrencies, Bitcoin was the most favored, its price rose from $1,153 at the beginning of the year to $20,000 at the end of the year. The cryptocurrency fad of 2017 came along with a lot of Ponzi schemes. These schemes came on the mantra of “getting in on the next big cryptocurrency” which never happened. The uptrend in crypto prices halted in 2018. The crypto market didn’t return to a bullish trend till 2020.

Why are Cryptocurrencies so Volatile?

There are a number of reasons for the volatility of cryptocurrencies some of which are:

No Intrinsic/Real Value: Cryptocurrencies unlike country currencies and other assets are not backed by any physical product or commodity. Regular currencies are backed by commodities like gold and the full-faith of their issuing authority, assets like stocks have companies running and generating revenue which is used for their valuation, but cryptocurrencies are not backed by anything, and so it is almost impossible to fundamentally derive their true value. Their price movement is driven mainly by market sentiments, making it very speculative. 

Limited Supply: The supply of most cryptocurrencies is fixed. Based on the law of demand and supply, when there is limited supply and mounting demand, prices shoot up. In situations where buyers are of the opinion that a cryptocurrency price has peaked, they sell-off.   

Market Size: The crypto market is an emerging market; the market is only about 10 years old. The entire crypto market as at the 6^th of April, 2021 was valued at $2trillion, while the foreign exchange market trades over $5trillion on a daily basis. This shows that the cryptocurrency market is not as liquid as the foreign exchange market and so it doesn’t enjoy the same level of stability that regular currencies have. This makes the cryptocurrency market subject to the dictates of traders who hold a substantial amount of cryptos (popularly called whales). Whales can determine the direction of the market with the size of their transactions.

Lack of Regulation: One of the most attractive features of cryptocurrency is that there are no regulations, this is also one of the reasons for its volatility. An unregulated market is subject to market/price manipulations that are not allowed in regulated markets. A global and unregulated market, that is very responsive to market developments will have erratic price swings.

On The Recent Bullish Run and Why there is a Dip Now

The cryptocurrency market started to gain traction again in 2020 during the pandemic and this time around, we saw a number of institutional investors come into the crypto market. The pandemic made a lot of businesses decentralize and go digital, making cryptocurrencies more relevant.  Companies like J.P Morgan, Black Rock, Garyscale & MicroStrategy invested in cryptocurrencies in 2020. Paypal integrated the use of cryptocurrencies into its platform earlier this year. The increased interest of institutional investors in cryptocurrency broadens the crypto market and reduces volatility in the market.

The recent dip in the market we believe is as a result of two things:

• Market Correction: Financial markets through the forces of demand & supply dictate asset prices, in cases where a financial instrument/asset has be bullish (an uptrend) for a long while, it gets to a point where it is overbought (when an asset is selling for an unjustifiably high price) at this point, market forces corrects the price of the asset/instrument by selling it. In a situation where an asset is oversold (selling at an unjustifiably low price) market forces corrects the price of the asset by buying it.

Bitcoin and a couple of its peers have been overvalued for a while and so market correction is one of the reasons for the recent dip.

• Portfolio Readjustment: Investment portfolios have allocations for each asset they hold i.e. assets must not exceed a certain percentage of the total portfolio. As asset prices change, each asset’s allocated quota in the portfolio also changes. Portfolio managers often adjust their portfolios to ensure each asset stays within its allocated quota in the portfolio. They do this by reducing their holdings of assets that have significantly increased in price.A number of investment banks added cryptocurrencies to their portfolios in 2020 and as the price of cryptocurrencies increase, they readjusted their portfolios by reducing their cryptocurrency holdings to keep cryptos within the allocated quota for their portfolios.

What do we expect from Cryptocurrencies in the near future?

Technology is revolutionizing the way we live and do business. As the world continues to evolve, and the blockchain technology cryptos run on improve, we expect cryptos to become more relevant and more countries and institutions embrace its use. Regulation will also come to play. We’ve already seen this happen in different countries. Crypto exchanges operating in different countries are requested to provide Know Your Customer (KYC) details of their users making the use of cryptocurrencies more transparent and less attractive to the dark world.

As more institutional investors come into the crypto market, we expect to see more stability in price movement of cryptocurrencies. Lower volatility notwithstanding, we expect a gradual rise in the value of the crypto market as a whole. The crypto market we believe will see the entry of more long-term investors as opposed to the mob of retail traders presently in the market.

How Do I Invest in Cryptocurrencies?

Cryptocurrencies are very speculative and so they are subject to wild price swings. As an investor, make sure you understand the difference between your willingness to take risk and ability to take risk before investing in cryptocurrencies.

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