Bitcoin, other cryptocurrencies plunge after China announces ban

Cryptocurrencies that seemed to be defying gravity just weeks ago came back down to earth with a bump on Wednesday after a roller-coaster ride which could undermine their potential as mainstream investments.

The two main digital currencies, bitcoin and ether, pared back their losses in early afternoon trading after two of their biggest backers — Tesla Inc. chief Elon Musk and Ark Invest's chief executive officer Cathie Wood — reiterated their support for bitcoin.

While many analysts thought the explosion in crypto interest this year was not sustainable, the trigger for the shake-out was China's move on Tuesday to ban financial and payment institutions from providing cryptocurrency services. The country also warned investors against speculative crypto trading.

At one point on Wednesday nearly $1 trillion US was wiped off the market capitalization of the entire crypto sector. In early afternoon trading, their market cap was $1.8 trillion, according to data tracker CoinGecko.com.

"There's a lot of leverage embedded into crypto stocks so there will be a spillover effect into equity markets in the short term and there is also quite the inflation fear as the market thinks the Fed might have to hike rates abruptly if prices keep rising," said Thomas Hayes, chair and managing member at hedge fund Great Hill Capital LLC.

Federal Reserve officials played down any risk to the wider financial system.

"By itself I don't see that as a systemic concern at this point," St. Louis Federal Reserve president James Bullard said. "We are all quite aware that crypto can be very volatile."

Nevertheless, a move into safe-haven U.S. Treasury securities knocked yields lower, while stocks were also on the defensive.

Bitcoin, the biggest and best-known cryptocurrency, had already been under pressure from a series of tweets from Musk, but the news from China sent it further down. It hit a three-and-a-half month low of $30,066.

Bitcoin down more than 50%

The cryptocurrency has dropped 54 per cent from a record high of $64,895 hit on April 14. It is also heading for its first monthly decline since November 2018.

"Bitcoin's sharp price drop should come as no shock to the market," said Gavin Smith, chief executive officer of crypto consortium Panxora.

"Any asset which has risen as much as bitcoin over the past year can be expected to have pullbacks as some investors withdraw profits, like we're currently seeing. While often a brilliant investment opportunity, traders must remember that Bitcoin is still an emerging asset class and will continue to experience large price swings," he said.

Bitcoin's decline whacked other crypto assets, with ether, the coin linked to the ethereum blockchain network, dropping to $1,790, its weakest level since late January. Since hitting a record high on May 12, ether has plummeted 57 per cent.

Doge down

Meme-based dogecoin also tumbled, losing nearly 26 per cent to $0.35, according to Coingecko.

Shares in the crypto exchange Coinbase dropped 7.4 per cent on Wednesday. Coinbase's share price has nearly halved from the peak hit on the day of its direct listing in April.

Tesla Inc. also fell, down 3.8 per cent to $555.83.

Cryptocurrency price declines last week were sparked by Musk's reversal on Tesla accepting bitcoin as payment. His subsequent tweets caused further confusion over whether the carmaker had shed its holdings of the coin.

China's announcement on Tuesday banning financial institutions and payment companies from providing services related to cryptocurrency transactions exacerbated selling. China also warned investors against speculative crypto trading.

"The crypto markets are currently processing a cascade of news that fuel the bear case for price development," said Ulrik Lykke, executive director at crypto hedge fund ARK36.

Some cryptowatchers, however, predicted more losses ahead, noting the fall below $40,000 represented a breach of a key technical barrier that could trigger more selling.

A "widespread deleveraging" was sweeping through cryptocurrency markets, said Saxo Bank's chief investment officer, Steen Jakobsen, calling the selloff deeper and more widespread than earlier episodes.

Inflation hedge?

Investors may also be exiting bitcoin for gold, analysts at JPMorgan said, citing positioning data compiled on basis of open interest in CME bitcoin futures contracts.

This shows "the steepest and more sustained liquidation" in bitcoin futures since last October, they told clients, adding that it pointed to "continued retrenchment by institutional investors."

The crypto asset selloff at a time when inflation fears are rising hurts the idea of the asset class as an inflation hedge.

Instead, more traditional hedges have been gaining ground, with gold up almost six per cent this month.

The recent selloff in bitcoin and other digital currencies has sent market capitalization of all cryptocurrencies to $1.7 trillion, down from the $2.5 trillion record hit earlier this month.