Bitcoin-mania is back with its dizzying rallies and sudden crashes. The cryptocurrency dropped by 8.4 per cent on Thursday after nearing a record high on Wednesday.
The slump comes after Bitcoin surged around 50 per cent over the past three months and 140 per cent this year. The digital currency was trading at around US$17,000 (around $22,082) early on Friday after hitting a three-year high of US$19,521 ($25,357) on Wednesday.
The drop has also dragged down other popular digital currencies like Ethereum and XRP, the third-biggest. Both coins, which tend to move in tandem with Bitcoin, had hit multi-year highs earlier this week.
Bitcoin enthusiasts see the drop as a minor correction triggered, at least in part, by tweets by the CEO of major cryptocurrency exchange Coinbase expressing concern at rumours of an impending U.S. regulatory crackdown.
Skeptics warn of another speculative bubble that will, eventually, burst.
But is this crypto rally different from the one that saw Bitcoin surge to an all-time high of nearly US$20,000 in December 2017?
The answer is “yes and no,” says Andreas Park, associate professor of finance at the University of Toronto.
Big business cozying up to crypto
One thing that’s different this time around is the interest in Bitcoin and other digital currencies from big business, Park says.
Paypal announced in October that it would enable U.S. account holders to buy, hold and sell cryptocurrency. Derivatives marketplace CME Group and Fidelity Investments Inc. also offer services that allow for buying and selling crypto assets.
JP Morgan Chase has created and tested its own digital token, JPM Coin, despite CEO Jamie Dimon having been a vocal critic of Bitcoin in the past. The investment banking giant has also started offering banking services to two well-known crypto exchanges, Coinbase and Gemini Trust.
Headlines about big companies and especially payment platforms stepping into the crypto space may have contributed to fuelling renewed excitement for crypto among the public, Park says.
Also, people can now buy digital currencies through exchange-traded funds (ETFs), he notes. As demand grows for these crypto ETFs, so does the funds’ need to buy more digital currencies, he notes.
But there are also a lot of projects underway that will offer more capabilities on the blockchain than simply trading digital tokens, Park says.
Blockchain is a digital ledger that makes it possible to keep track of who owns what and when that ownership is transferred.
“Bitcoin is, essentially, blockchain 1.0,” he says. “The only thing you can do with bitcoin is to transfer bitcoins between different addresses.”
The technology behind Ethereum, on the other hand, allows for a much broader array of potential applications, including setting up financial contracts and escrow accounts, conducting auctions and lending, Park says.
Recent progress toward a broader range of blockchain functionalities with Ethereum and other digital currencies may have also helped drive up their value, according to Park.
Have regulators caught up with crypto?
For all the advances on blockchain applications since the last crypto craze, buying Bitcoin in hopes its value will go up remains “a bet, essentially,” as Park puts it.
One well-known risk of pouring money into Bitcoin and other cryptocurrencies is their extreme volatility.
Another risk involves relying on intermediaries such as crypto exchanges to hold your digital tokens. While it’s impossible to delete or hide transactions on the blockchain, it’s entirely possible to separate digital currencies from their rightful owners.
Canada’s now-defunct crypto exchange QuadrigaCX, for example, operated like a Ponzi scheme, according to the Ontario Securities Commission.
“Clients entrusted their assets to Quadriga, which provided false assurances that those assets would be safeguarded,” the OSC wrote in a scathing report published earlier this year.
In reality, the company’s CEO, Gerald Cotten, who died suddenly in India in December 2018, used clients’ assets at will, the OSC said.
“Cotten was able to misuse client assets for years, unchecked and undetected, ultimately bringing down the entire platform,” the OSC report reads.
When Quadriga filed for creditor protection following Cotten’s death, the platform owed $215 million to more than 76,000 clients. Ernst & Young, the bankruptcy trustee, was able to recover or identify just $46 million, leaving a shortfall of at least $169 million.
In both the U.S. and Canada, regulators have stepped up scrutiny of crypto trading platforms and established new rules for digital currencies.
In Canada, the rules require crypto exchanges that handle digital currencies like securities to register with securities regulators.
However, “many crypto asset trading platforms are not registered and have taken the position that they are not required to register with securities regulators,” the OSC noted in its June report on Quadriga.
Using the platforms carries risk because they keep control of clients’ digital assets, the OSC warned.
“Clients merely have claims against the platform for those assets. These claims are vulnerable to the solvency, proficiency and integrity of the platform operators,” the report says.
— With files from Reuters