The cryptocurrency asset class has been evolving for over a decade. Over the past twelve years, it has built a notable reputation and gradually moved closer to mainstream financial assets, though it still has a considerable journey ahead.
As of recent data, the total market capitalization of cryptocurrencies stands at approximately $1.235 trillion. This is significantly less than the market value of Apple Inc., the world's largest publicly traded company, which is valued at around $2.38 trillion.
Cryptocurrencies are products of blockchain technology, representing an evolution in financial technology and a revolutionary method of conducting transactions. They also embody a political movement by shifting control over monetary supply from governments to individuals.
For traditional investors, as famously stated by Charlie Munger, cryptocurrencies are often viewed as "a threat to civilization." The divide between proponents and critics remains highly polarized.
Moreover, the astonishing returns seen in Bitcoin, Ethereum, and numerous other cryptocurrencies fueled a speculative frenzy that peaked on November 10, 2021, when prices reached all-time highs.
Since then, the trend for leading cryptocurrencies has reversed, with prices declining steadily and hitting a low on January 24, 2022, marking the end of the bullish rally.
Digital currencies have largely been in a downward trend since that period, with liquidity drying up significantly in recent weeks. In the current environment, the possibility of false breakouts is increasing.
Understanding Market Volatility
In 2021, when Bitcoin approached $70,000 per token, many optimistic analysts predicted that the leading cryptocurrency would reach $100,000 by the end of the year. Those predictions clearly did not materialize.
Long-term charts indicate that Bitcoin's upward momentum was exhausted by November 2021. Since then, the leading cryptocurrency has faced persistent selling pressure. Recently, Bitcoin hit a new low for 2022, reaching its lowest price since December 2020 at around $25,919.52 per token.
Similarly, Ethereum dropped to a low of approximately $1,721.47 on May 12, marking its lowest price since June 2021.
Historical Context and Identity Challenges
The voices of critics like Charlie Munger and Warren Buffett have grown louder, overshadowing the earlier calls for Bitcoin to reach $100,000.
Peter Thiel, a prominent cryptocurrency supporter and co-founder of PayPal, referred to Warren Buffett as Bitcoin's number one enemy and a "sociopathic grandpa." Recently, at a Berkshire Hathaway meeting, Buffett stated, "If you owned all of the Bitcoin in the world and you offered it to me for $25, I wouldn't take it."
Buffett does not consider Bitcoin or other cryptocurrencies to be productive assets. He believes they are headed for a bad ending. His partner, Charlie Munger, went further, calling cryptocurrencies "stupid and evil"—stupid because they will "go to zero," and evil because they "undermine the Federal Reserve System."
This conflict represents a generational divide, pitting the existing financial system against emerging financial technology. The lack of a long history and a stable identity for this new asset class has resulted in significant volatility. The total market capitalization of cryptocurrencies rose to around $3 trillion by the end of 2021 but fell to $1.235 trillion as of mid-May 2022.
Speculative Sentiment and Market Participation
Nothing drives prices higher like a bullish trend. In the cryptocurrency world, Bitcoin's rise from $0.05 in 2010 to nearly $69,000 in November 2021 triggered a wave of speculative buying.
The prospect of turning $100 into $138 million acted as a powerful magnet. As prices climbed, more buyers entered the market for Bitcoin, Ethereum, and an increasing number of altcoins, creating the potential for easy and extraordinary wealth.
The price reversal on November 10, 2021, did not immediately dampen speculative enthusiasm. Many market participants bought during the initial price dips. However, the persistent decline and lack of substantial rebounds eventually deflated the speculative bubble, turning hopes of massive profits into significant losses.
While bullish trends spark speculative buying, the path of least resistance in a bear market replaces greed with fear, causing many speculators to step back and adopt a wait-and-see approach.
The Stability Question with Stablecoins
Recent challenges in the cryptocurrency space have led to declining liquidity, exacerbated by the withdrawal of speculators. Stablecoins, which are cryptocurrencies pegged to another asset like a fiat currency or a traded commodity, are meant to maintain a stable value.
TerraUSD (UST) was a decentralized algorithmic stablecoin that used complex code to create or destroy tokens to maintain a stable price of $1. It also had a governance token designed to provide stability.
Charts show that from November 2020 to May 7, 2022, UST maintained its value at or near $1. After that, it plummeted to less than 20 cents by the end of the week. The instability of this "stablecoin" caused panic across the cryptocurrency asset class.
Other stablecoins have managed to maintain their value, but the overall trend for the more than 19,000 other cryptocurrencies remains challenging.
Liquidity and Volatility Impact
With the lack of upward momentum, many speculators have exited the cryptocurrency market. Reduced participation leads to lower liquidity, which often results in increased price volatility.
As market engagement decreases, the number of sellers during rallies and buyers during dips diminishes, causing price gaps and violations of technical support and resistance levels.
The decline in cryptocurrency liquidity is likely to amplify price discrepancies in the coming weeks and months. Higher volatility increases the potential for false technical breakouts in both upward and downward directions.
Meanwhile, while those calling for Bitcoin to reach $100,000 in 2021 were incorrect, those predicting it will go to zero in 2022 are also likely mistaken. The risk-reward profile for cryptocurrencies improves at lower prices, but any investment carries the possibility of a total loss.
Returns come with risks, and volatility magnifies them. It is essential to approach cryptocurrencies with caution. Every dollar invested could yield substantial profits, but it also comes with significant risk.
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Frequently Asked Questions
What causes cryptocurrency volatility?
Cryptocurrency volatility is driven by market sentiment, regulatory news, technological developments, and liquidity conditions. The relatively small market size compared to traditional assets amplifies price swings.
How do stablecoins maintain their value?
Stablecoins aim to maintain a stable value by being pegged to reserves like fiat currencies or algorithms. However, as seen with UST, algorithmic models can fail under extreme market conditions.
Is now a good time to invest in cryptocurrencies?
The current market offers lower entry points but remains highly volatile. Investors should conduct thorough research, assess their risk tolerance, and consider diversification before investing.
What is the long-term outlook for cryptocurrencies?
While short-term trends are uncertain, blockchain technology continues to evolve. Cryptocurrencies may gain broader adoption, but regulatory and market challenges persist.
How can investors manage risks in crypto investments?
Risk management strategies include diversification, setting stop-loss orders, and only investing funds one can afford to lose. Staying informed about market trends is also crucial.
Are cryptocurrencies a threat to traditional finance?
Cryptocurrencies challenge traditional financial systems by offering decentralization. However, they currently coexist with conventional assets, and their overall impact remains a topic of debate.