During the crypto bubble glory days – now exactly one year ago – Koen’s telephone buzzed incessantly. In a Whatsapp group, he shared portfolio performance and exchanged recommendations with friends on cryptocurrency prices. They were fanatical and there was no end to what Koen and his friends would share regarding their profits. The 23-year-old strategic management master’s student also hit the jackpot. “At one point I had earned 900% on my initial investment.”
The past year was the polar opposite of 2018, and Koen’s group app illustrates this perfectly. The silence, compared to 2017, is almost uncomfortable. It’s not as much fun to share your losses, he says laughing. An example: Bitcoin prices have dropped more than eighty percent compared to last year, and the same applies for all the major cryptocoins that peaked around the end of December 2017. For Koen, the current status of his portfolio is a private matter, but he does say he wishes he had cashed in during the crypto heyday.
2018 is the year of the crypto plunge, the ‘rude awakening’, as Information Management professor Peter Vervest puts it. What caused the crypto crash? And what does this drop in value mean for the future of digital currencies?
Unregulated Wild West
A cryptocurrency is a digital currency unit that is stored in a blockchain, a series of computers that jointly store encrypted information. The principal digital coin, the Bitcoin, was valued at 17,000 euro in 2017, but its price is now around 3,126 euro. How did the coin drop in value so quickly?
Various reasons are given. The main reason according to Vervest: “The investments everyone was making in cryptocurrencies and their runaway expectations were too high and unrealistic. It turned into a hype.” says Vervest. All this happened when the market was still in its infancy. “It’s an unregulated Wild West. Fortune seekers can also contaminate the market by issuing worthless currency units.”
Another factor is that trading in digital currencies is even more sensitive to the behaviour of speculators anticipating how others will act, and in doing so, the hype is exacerbated, says Laurens Swinkels, an assistant professor at Erasmus School of Economics. He compared the crypto market to the regular market. “That’s because it’s hard to determine the value of cryptocoins. With regular shares, you buy shares from a company that generates a measurable output. This is used as a foundation for determining and verifying the value of shares.”
‘A classic bubble’
These ingredients combine to create a classic financial bubble, according to Mary Pieterse-Bloem, an endowed professor in financial markets at Erasmus University and Senior Global Head Fixed Income at ABN-AMRO. “You can compare it to other bubbles, such as the housing bubble at the start of this millennium. At that time people thought house prices would keep rising. When that happens, more and more people invest in that sector in anticipation of this trend. This then creates a bubble, and the price rises above the actual value.”
Sooner or later the bubble bursts. In retrospect, Koen (surname withheld upon request, see explanatory note) explains why he thinks the bubble burst: “There were signs that some governments, like South Korea, and agencies such as the American Securities & Exchange Commission had plans to prohibit cryptocurrencies. And Coincheck, a major Japanese cryptocurrency stock exchange, was hacked to the tune of 530 million dollars. That was a blow to people’s confidence and caused the market to collapse.” In spite of the crash, Koen, who is exploring investment in more depth with the student investment association B&R Beurs, continues to invest in cryptocurrencies.
Rogue investors and money-grubbers
In contrast with the housing market bubble that resulted in the big financial crisis of 2008, the bursting of the crypto bubble has had little effect on the economy. Why is that? “Simply put, the market is much smaller, and so it has less of an impact,” explains Pieterse-Bloem.
In Vervest’s opinion, the crash was a good thing. “The wheat has been separated from the chaff. The rogue investors have suffered and you see the money-grubbers retreating with their tails between their legs. People who continue to invest in cryptocoins are the ones who truly believe in the technology. For example, the price of Bitcoin is still three times higher than it was in early 2017. It’s now much more in line with the actual value of the technology behind it.”
The ‘fools’ who decided to invest at the peak period have lost their money. “It evaporated. The sellers at the other end of the deal and currency owners have the upper hand”, says Pieterse-Bloem. “But I haven’t heard of people having financial problems by buying cryptocurrencies late in the game. Those were people who – luckily – could afford to lose the money.”
Four times more energy than Google
Does this crash mean the end of cryptocurrencies? Pieterse-Bloem: “That’s difficult to predict. It’s pretty certain that it will never totally disappear, because it’s a useful payment instrument for criminals who value their anonymity.”
If the coin is to be used as a payment instrument in the regular market, it still has some obstacles to overcome. “An effective currency has to be reliable, but crypto coins are anything but stable. If you can use it today to buy a car, it’s uncertain whether you’ll be able to buy half a car for the same amount tomorrow.”
According to Pieterse-Bloem, in order to be able to consider a currency as reliable, you need transparency, regulation and stability. An important factor here is that governments recognise cryptocurrencies as a payment instrument.” And that is where she has her doubts. “If that should happen, the government relinquishes its influence: with cryptocurrencies in their current form, you can’t regulate and steer the economy.”
Another problem involves environmental concerns. “You need an enormous amount of energy to develop cryptocurrencies. At this time, Bitcoin uses four times more energy than all the Google servers in the world combined. That’s 22 terawatt hours per year, and that will grow exponentially if the entire economy uses cryptocoins.”
‘Revolutionary’ and ‘idealistic’ technology
Vervest emphasises that in spite of the problems, he has confidence in the technology driving cryptocurrencies – blockchain. “Thanks to this technology, we’ll be able to execute transactions without a third party in the future. That’s revolutionary.
Koen explains how blockchain and Bitcoin works and why it’s important: “Every computer has a ledger: a copy of all transactions between all addresses. You can look at this as accounts on the blockchain. This kind of information is currently stored at banks.”
Koen believes blockchain is more secure. “Instead of a single, vulnerable location where account information is stored, copies of all the data are stored in all computers forming part of the chain. If a malicious hacker changes the data of a single computer in the blockchain to appropriate money, that computer is immediately identified by other computers as a provider of incorrect information. The hacker is unable to do what he set out to do. Complete transparency takes trust out of the equation. Furthermore, intermediary third parties aren’t needed to execute a transaction in this type of system. Everything is based on consensus within the blockchain network.”
There’s also an idealistic side to cryptocurrencies, says Koen, and that’s something he admires. “Satoshi Nakamoto invented Bitcoin based on the idea that things could be done without bankers, especially after the bank crisis of 2008. He saw bankers as the culprits responsible for the crisis.” Will his telephone be buzzing like it did in 2017? It’s too soon to tell, but he expects it will. And personally, this appeals to him, even if it’s only because of the idealism behind it.
Koen elected not to disclose his surname in this article. In an email he wrote: “These kinds of articles could influence an employer’s perception of me if they look me up, so that’s a no reward/high risk choice.”