Bitcoin investors are really suffering right now.
The emergence of crypto markets has been "one of the most rapid wealth creation events in human history," with the total market capitalization rising by 2,761% between mid-June 2017 and the start of November 2021, Paul Hickey, co-founder of Bespoke Investment Group, wrote in a note to clients Monday morning.
"Wealth destruction is proving almost as rapid on the downside," Hickey added.
Bitcoin's price has fallen around 16% in the last 24 hours and 25% over the last seven days, according to data from CoinMarketCap.
Why bitcoin is down
Here are some of the reasons why prices for bitcoin (and other cryptos) are taking a nosedive:
The Fed and economy
Throughout the pandemic, financial markets were buoyed by stimulus money from the government and near-zero interest rates that made it easy for businesses and consumers to borrow and spend. There was lots of money sloshing around and making its way into risk assets like stocks and crypto — not to mention collectibles like Pokemon and baseball cards, says Omar Qureshi, investment strategist at Hightower Wealth Advisors.
"The market now perceives this to be the Fed draining liquidity from the system, having much tighter monetary policy and slowing the economy," Qureshi says. "All of those things are serving to basically pop that bubble of risk-taking."
Bitcoin is certainly risky, and when financial markets are hurting you're going to feel the most pain in the places the farthest out on the risk spectrum, he adds.
Leverage and forced selling
It's not just that investors are scared of riskier assets right now — they may actually be forced to sell bitcoin.
Crypto tends to have a lot of cross-correlation risk because most exchanges will allow you to collateralize margin positions in crypto with other crypto, Stéphane Ouellette, CEO and cofounder of FRNT Financial, a capital markets platform, told Money via email.
Margin trading in crypto is essentially when traders who want to take a bigger position in a cryptocurrency like bitcoin access leverage from exchanges to do so. Traders who engage in this kind of margin trading run the risk of their investments being automatically liquidated when the price of bitcoin falls below the requirement to ensure ongoing collateralization. This manifests itself with exchanges often force-selling client positions at the market during price downturns.
Traders can also leverage bitcoin to bet on altcoins — the name for cryptos other than bitcoin like dogecoin or shiba inu coin. There continues to be a very strong argument that some altcoin valuations are inflated, Ouellette adds. If the altcoin plummets, the exchange may liquidate a trader's bitcoin as a form of collateral to ensure the exchange's lending facility can pay obligations to all parties.
Erosion of confidence in cryptos
While the Fed's moves and forced selling are major reasons for bitcoin's selloff, some recent events could be accelerating the price drop, says Martin Leinweber, digital asset product strategist at MarketVector, an index provider
In May, a crypto called luna collapsed, as did terra, its associated "stablecoin" — the name for a cryptocurrency with value tied to another asset like the U.S. dollar. Billions of dollars were wiped out, and fear struck the crypto community.
More recently, the Celsius Network, one of the largest crypto lenders, told its users Sunday that due to extreme market conditions, it was pausing all withdrawals, swaps and transfers between accounts.
"We have extreme fear and extreme panic" around crypto right now, Leinweber says. Now with bitcoin and ether plummeting, that panic has reached the number one and number two cryptocurrencies in the market, he adds.
Crypto buyers tend to be especially speculative buyers, and prices can rise or fall incredibly quickly based on what people believe at the moment.
"When confidence erodes, when bearishness comes into play, when speculators pull back — either because they're forced to or they just don't want to lose any more money — your natural buyer is gone from the market," Qureshi says. "So who steps in to buy these dips?"
It's different from, say, Apple stock, in which investors look over dividends and earnings reports to determine at which price the stock may be a good buy. That's much tougher to figure out with crypto.
"This will end when all sellers are done selling," Qureshi adds.