Many believe that cryptocurrencies are in a bubble. Therefore, what can make it burst? With the growth of cryptocurrencies in 2017, it will be interesting to see where the market will go this year. More importantly, investors must stay aware of the potential risks associated with the highly volatile market.
Here are four factors that can trigger a significant cryptocurrency market crash. There is a possibility that the larger a cryptocurrency is, the impact when it crashes will be greater. As the market capitalization of cryptocurrencies has been increasing exponentially, the market may be gearing towards a tremendous decline. However, it is difficult to point whether it is the start of an increase or a decrease.
The cryptocurrency high had the market value of nearly $563 billion. Comparing this to the value in early 2017, the market has grown exponentially. For tokens that rely mainly on speculation to increase in value, this market has certainly taken off. In fact, some cryptocurrencies have been increasing by several thousand percents. More people are searching for cryptocurrencies on Google. The cryptocurrency market is one of the easiest ways for people to become rich overnight, which is why many have expressed their interest in this trade.
However, there is one important question that we need to ask.
Is this growth rate sustainable?
Some believe that the cryptocurrency market may be in a huge bubble that is waiting to pop. In fact, it is important to consider worst-case scenarios so investors can prepare their exit strategy. Regardless of what the future holds, investors must stay aware that the cryptocurrency market presents a variety of risks not available in the traditional assets market.
To understand the risk better, an important question to ask is: what can make the cryptocurrency market burst? Finding the right answer is not always easy, but here are some potential triggers.
- Increased regulation
If anything, we have seen many governments around the world taking a neutral stance on cryptocurrencies. In fact, many are undecided about when they should step in to regulate cryptocurrencies. If the major economies in the world such as the United States and the European Union decided to ban exchanges altogether, this could cause a detrimental impact on cryptocurrencies. However, some may argue that cryptocurrency cannot be fully eliminated due to its nature.
One of the countries known to have an authoritarian grip on its economy and citizens is China. Therefore, it doesn’t come as a surprise that the Chinese government imposed an absolute ban on the trading of cryptocurrencies and ICO in mid-September 2017. However, this doesn’t completely wipe away the presence of Chinese investors in cryptocurrency. They simply moved their funds to other countries to trade cryptocurrencies. Many were expecting the market to collapse as Chinese investors often hold a large stake in the cryptocurrency market. However, the market rallied instead of collapsing.
With the increase of fraud in initial coin offerings, investors should be aware of where the US and Europe regulators are heading. What would happen if the US and Europe were to ban cryptocurrencies? However, the likelihood of Western economies completely banning cryptocurrencies is very low.
- Powerful exchanges
Mt. Gox was a powerful cryptocurrency exchange. Before 2014, it accounted for over 70% of all trading volume. When it suspended trading at the beginning of the year, 80% of the cryptocurrency market crashed from its high. Some are concerned that the same thing will happen again. However, there are reasons to believe that trading today is more distributed and there are very few exchanges that have a monopoly on the entire trading volume.
Despite that, there are some significant exchanges that play an important role. Coinbase and its backend solution GDax are one of the largest exchanges in the world and bring in fiat money into their system. Therefore, it may not have the largest trading volume in the ecosystem, but these are still exchanges that play an important role in the ecosystem.
On the crypto-to-crypto side, there is a scarier outlook. Binance, which is a relatively new exchange is now one of the largest exchanges in the world in terms of trading volume. It is important that investors start thinking about the risk of letting powerful exchanges hold a lot of money in the cryptocurrency market. They bear a huge impact on the cryptocurrency community if something does happen to it.
While most exchanges try their best to ensure that users’ assets are protected, there is no guarantee that nothing will happen to the exchange. In fact, even when the capabilities of Mt. Gox were at its peak, it still wasn’t able to ensure that its users’ funds stay safe. There is always the risk of one or more of these exchanges going wrong. If this does happen, it will result in a lot of coins getting locked up.
- Credit facility
There are some exchanges that allow users to purchase cryptocurrencies using credit cards. In fact, investors can leverage their purchases in many cases. The main concern that credit card providers have about providing this method is that nearly 4% of the purchases made on credit card cannot be repaid. This is probably one of the reasons why very few exchanges offer credit and debit cards as a method of payment.
What this means is that any extended sideways movement can mean bad news for people who use credit cards. However, the impact of this on the cryptocurrency market is minimal as not many exchanges accept this method of payment.
If you see that the market capitalization of a cryptocurrency is $100 million, it doesn’t mean that the cryptocurrency has received $100 million worth of payment. In fact, the $100 million is simply the total market capitalization which is obtained by multiplying the number of tokens in circulation by the trading price. The good thing about it is that even if the market crashes, investors may only lose a portion of this amount as the amount invested is a lot less than the increased valuation.
To this, there is one huge exception. It’s the cryptocurrency, Tether.
Tether’s market capitalization is currently at $1.6 billion. In their case, it also means that the equal amount of money goes into the cryptocurrency. However, reports state that this cryptocurrency doesn’t exactly have $1.6 billion backing up the token. As it is connected to many other exchanges in cryptocurrencies, the market can go into a significant decline if something happens to it.
The future outlook
Looking at all these factors, there are a few things that become clear. Even if the cryptocurrency seems huge, it most probably won’t impact the market in the long term. As there are nearly 2000 cryptocurrencies in the market today, and the impact will be minimal unless it is a major cryptocurrency. While all of these may not happen in 2018, it’s important that investors take precautionary measures to diversify their investment into other cryptocurrencies and traditional assets.