Crypto Chaos: Why Did the Bubble Burst?

What to Know Before Reading:

  • A cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions
  • The oldest, most valuable and most famous cryptocurrency is Bitcoin. The other major coins are Ethereum, Ripple and Litecoin.
  • The primary crypto price trackers are Coincodex, Coingecko, and CoinMarketCap.
  • The primary crypto exchanges (where the coins are traded) are Binance, Coinbase, and Bittrex.
 

n the 7th of January 2018, the total market cap for the cryptocurrency market was around $820 billion. On the 6th of February of the same year, the market cap was $279 billion; the Cryptocurrency market had fallen 65% in just a month. If this happened to the NYSE, to say there would be chaos would be understatement; it would probably have been the stuff of nightmares. Such a plunge in almost any other market would not only be unprecedented, but would be talked about for decades to come. Bitcoin crashed from $17k to $6K, and Ripple dropped from $3.3 to $0.65. Billions of dollars simply vanished from the cryptocurrency space. But why?

The general consensus is that the crash was initiated by the highly popular cryptocurrency price tracker “CoinMarketCap”. CoinMarketCap, used by the majority of cryptocurrency enthusiasts to track the average day-to-day prices of cryptocurrencies, is thought to have started the crypto crash when it suddenly removed one of the three biggest crypto exchanges from its price calculations. Bithumb, a cryptocurrency exchange used predominantly in Asia, was removed from CoinMarketCap’s price estimates in the early hours of January 8th. The average prices on Bithumb were much higher than the average prices on the other crypto exchanges around the world. Consequently, by removing Bithumb from CoinMarketCap’s average price calculations, the average price dropped considerably. Such a decision would have caused merely a slight dip in the overall market were it announced to the world beforehand. However, it wasn’t.

As a result, the morning of January 8th, the Western world awoke to a sea of red on CoinMarketCap’s price indexes. Everything had plummeted, and nobody knew why. For all the months previously, crypto investors had woken up to find that their investments reaching a new high; cryptocurrency seemed to be a money-making guarantee, as long as bubble continued to grow. It was for this exact reason that everyone panicked: that morning, it seemed as though the bubble had burst. The irony of the this is that, because so many genuinely believed the bubble had burst, it actually did. In the following days, hundreds of thousands of investors sold their cryptocurrencies, taking their profits, or what remained of their profits, with them. It soon became clear that the cause of the initial drop in prices was simply due to a correction in CoinMarketCap’s price estimate; however, by that time, a second and more ominous cause for a crash had already been set in motion: the panic and flight of the uninformed.

The reason why the Crypto crash continued even after CoinMarketCap announced that they had simply removed Bithumb from their price calculations was that the Crypto market was, and still is, filled with uninformed investors. Cryptocurrencies had become a craze. Youtube channels such as Crypto Daily and Datadash had seen their subscriber levels surge as they pumped out video after video about which coin would be “the next bitcoin”. Stories rapidly emerged about those who had bought Bitcoin when it was $1 and were now sitting on tens of millions, living a life of luxury. The FOMO effect by January 2018 was colossal. Hundreds of thousands of individuals had a stake in some cryptocurrency simply due to the fear of missing out, and not, crucially, because they actually knew what they were investing in. Consequently these investors, upon seeing prices drop, panicked and sold. When those who had initially held their position saw that others were selling, they too sold, and so a cycle was created, one that drove almost all of the bandwagon investors out of the market (which was basically everyone!).

At this time of writing the market cap currently sits at $387 billion, highlighting the fact that the markets have recovered slightly from the January drop. The market seems to have leveled out in recent weeks around the $400 billion mark, prompting many to call the flash-crash earlier this year a “market correction” rather than the bursting of the crypto bubble as a whole. Many of crypto’s biggest investors are still in the game, certain the prices will skyrocket again as they did in 2017. They are convinced that this really is the technology of the future. However with multiple countries choosing to ban crypto exchanges in recent months, such as South Korea and China, I wouldn’t be so sure.