Bitcoin: Why has the cryptocurrency's value plummeted?

Bitcoin is a notoriously volatile currency and its value has swung wildly in recent weeks

The value of bitcoin has fluctuated wildly in the past week. After hitting a new high at the beginning of the week of around $20,000 it has now lost around a third of its value after crashing dramatically on Friday. There are several theories as to why this happened.

Herd mentality

The factor most likely to be driving the price down is that people are just simply following what everyone else is doing.

Tech entrepreneur and investor Oliver Isaacs said that the fluctuations were being driven a “herd mentality” amongst investors.

“Just as people feared missing out on the way up, the idea you can actually lose money is also a new emotion investors are experiencing and people, especially retail investors are selling manically on the way down,” Mr Isaacs said.

Unlike many other investments, bitcoin is not regulated, so there are no rules in place to stop a full-blown sell off in the event of a market panic.

Flee to safety

Another factor may be that investors are looking to move to less risky investments towards the end of the year.

Bitcoin whale sells stake

Kerim Derhalli, founder and CEO of finace app Invstr, thinks that someone with a large stockpile of bitcoin could have made it available to the market.

“This increase in availability could have initially driven prices down, with other holders – especially those that bought at the top of the market – panicked into offloading as a result,” Mr Derhalli said.

Competition

Bitcoin is also facing stiff competition from other cryptocurrencies, which aim to improve on aspects of bitcoin.

“A lot of the capital is flowing from bitcoin into alt-coins. Companies like Verge and Ripple, have seen cryptocurrency values go up over 400 per cent in the last week,” said Mr Isaacs.

However, all major cryptocurrencies experienced big losses on Friday.

Will it continue to fall?

That is impossible to say. Michael Jackson, partner at venture capital firm Mangrove Capital Partners, believes the price will rally.

"The vast majority of long-term holders of bitcoin are still way in the money and have shown no sign of cashing out. We see the exit of short-term speculators and we have seen it before,” he said.

“The fundamentals are still in place and there is no reason why the bitcoin ecosystem should not continue to develop,” he added.

Why has bitcoin been so volatile?

The highly speculative nature of cryptocurrencies and the fact that they are not regulated by any central bank makes them very volatile.

“Whereas a central bank stands behind and stabilises traditional currencies, there is no bank, corporation or government acting as a backbone to bitcoin,” said Mark Ward, head of trading at Sanlam UK.

“This is why the value of cryptocurrencies are so volatile – its value derives from the confidence in the market that tomorrow, the bitcoin will not be worthless,” he added.

Hacks

Investors worried about the security of cryptocurrencies can also be scared off by security breaches.

Cryptocurrency exchanges have also faced a number of hacks in recent months.

North Korea is being investigated for possible involvement in a massive cyber-attack on a South Korean currency exchange after hackers stole 17 per cent of its assets.

This sparked a sell-off in bitcoin and other cryptocurrencies, with prices plunging about 15 per cent in Asian trade before recovering.

Bitcoin recently moved closer towards being seen as a mainstream financial investment after the launch of futures contracts tied to the cryptocurrency’s price.

The world’s biggest exchange operator by value, CME Group, launched the futures, which allow traders to bet on the future value of bitcoin. Around $50m (£37.4m) of contracts changed hands in the first three hours of trading.

What will happen in 2018?

Many economists believe bitcoin remains a major gamble and there are concerns that the crypotocurrecy’s value could crash.

If you are thinking of investing in bitcoin it is advisable to make sure you understand bitcoin and what drives the price up or down before committing any money.

You should also be willing to sustain the large losses which could stem from the volatility of the cryptocurrency.

Mr Derhalli said that as cryptocurrencies continue to mature into an asset class of their own, we should see levels of volatility decrease.

“However, there is some way to go yet, but investors would be wise to look at the long term picture rather than short-term ups and downs,” he said.

Mr Ward said that the future of cryptocurrencies could depend on whether they receive endorsement from central banks and government and if the price stabilises.

“Whether bitcoin falls to near-zero, continues to rise like diamonds have over the past century, or simply holds steady once the market finds the level it can tolerate, is anyone’s guess at the moment, but it is certainly one to watch as it becomes better understood by the mainstream,” he said.

Mr Issacs believes that prices will continue to rise over the next year despite the massive swings.

“The top driving factor behind cryptocurrencies price increase, especially in the last few months has been wider mainstream awareness and acceptance,” he said.

“Many well-known businesses have begun accepting bitcoins as a means of transaction, such as Reddit and Wordpress, as well as a number of online retailers, not to mention the patents filed and domain names registered from billion dollar companies like Apple and Amazon.”