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Bitcoin got off to a solid start into 2021, hitting an all-time high of nearly $ 65,000 in April. But the digital coin closed the first half of the year down about 47% from its record – and a number of looming risks could lead to further pain.
While proponents are sticking to Bitcoin for now, other investors are wary of the wild volatility in the market and the importance it means to their portfolios. With that in mind, here are five of the biggest risks to cryptocurrency as we move into the second half of the year.
One of the biggest risks to Bitcoin right now is regulation.
In the past few weeks, China has cracked down on its cryptocurrency industry, halting energy-intensive crypto mining operations, and ordering major banks and payment companies like Alipay not to do business with crypto companies.
Last week, the global crypto crackdown spread to the UK, where regulators have banned the leading digital currency exchange, Binance, from conducting regulated activities.
Simon Yu, co-founder and CEO of crypto cashback startup StormX, told CNBC that China’s moves should be seen as a “positive” thing for Bitcoin and other cryptocurrencies like ether, as it will lead to more decentralization. However, he added that the “overregulation” of crypto in the United States could be an issue.
“As a country, the US has too many departments that regulate it from different angles – is crypto a security? A commodity? A quality? ”Said Yu. “Until now, the US has not figured out how to properly regulate the industry, which often leads to decisions that are difficult for crypto to manipulate.”
US Treasury Secretary Janet Yellen and other officials recently warned against the use of cryptocurrencies for illegal transactions.
Last year, the former President Donald Trump’s administration proposed an anti-money laundering rule that would require people who keep their cryptos in a private digital wallet to undergo identity verification when making transactions of $ 3,000 or more make.
“We have long warned that changing investor sentiment or regulatory crackdowns could burst bubble-like crypto markets,” UBS wrote in a press release this week.
Another major risk is persistent, extreme price fluctuations in Bitcoin and other digital currencies.
Bitcoin rebounded to an all-time record of around $ 64,829 in April of this year, on the day of the Coinbase cryptocurrency exchange’s blockbuster debut. It then fell to $ 28,911 in June, briefly slipped below $ 30,000 and turned negative for the year. It has since climbed back to over $ 34,000.
Bitcoin bulls see it as a type of “digital gold” – an asset that does not correlate with the broader marker and could generate sizeable returns in times of economic turmoil. But while volatility can be good when the price of an asset goes up, it goes both ways.
While you would have doubled your money if you had bought Bitcoin in January and cashed out in April, those returns would have been 18% year-to-date. However, this is above the performance of the S&P 500 index, which is up 16% since the start of the year. And in the past 12 months, the price of Bitcoin has more than tripled.
“A limited, highly inelastic supply of individual cryptos can exacerbate volatility,” says UBS. “The limited real world usage and exceptional price volatility also suggest that many buyers are looking for speculative profits.”
Meanwhile, the trend of traders placing heavily leveraged bets on Bitcoin being flushed out of the market has resulted in sharp price volatility this year.
While the persistent volatility might put some investors off, Ross Middleton, chief financial officer of the decentralized financial platform DeversiFi, said that volatility in and of itself is not a barrier to institutional adoption.
Volatility “can actually be a significant draw, as the potential for large price movements means funds with a relatively small allocation compared to the size of their overall portfolio can generate significant profits,” he told CNBC.
“The longer Bitcoin moves sideways in the $ 30 to $ 40,000 range,” added Middleton, “the greater the perceived” base build “and the more likely new capital will flow into both the asset and the broader crypto market.”
Musk’s electric car company stunned Bitcoin fans and skeptics alike this year when it bought the $ 1.5 billion digital currency and began accepting it as a form of payment. However, he later upset the crypto markets after deciding to stop Bitcoin payments due to the currency’s “insane” energy use and reliance on fossil fuels.
This raises some questions for asset managers who are under increased pressure to limit their investments to ethically conscious assets.
“At the very least, it could deter some investors from holding Bitcoin,” Citi analysts wrote in a research note earlier this year, adding that it could also “encourage government intervention to ban mining, as seen in parts of China.”
So-called stablecoins, the prices of which are supposed to be linked to real assets such as the US dollar, are also increasingly in focus.
Last week, the President of the Federal Reserve Bank of Boston, Eric Rosengren, said Tether a stablecoin, which is one of the largest digital currencies in the world, posed a risk to the stability of the financial system.
Tether claims that each of its tokens is backed 1: 1 by US dollars, which are held in a reserve to keep the price stable. Crypto investors often use tether to buy cryptocurrencies as an alternative to the greenback. However, some investors fear that Tether’s issuer does not have enough dollar reserves to justify its dollar peg.
In May, the company behind Tether collapsed its reserves for the stablecoin, revealing that around 76% was covered by cash and cash equivalents – but just under 4% of that was cash, while about 65% was commercial paper, a form of form of short-term debt.
Tether has been compared to traditional money market funds – but without the regulation – and has more deposits than many US banks with tokens in circulation valued at nearly $ 60 billion.
There have long been concerns about using Tether to manipulate Bitcoin prices, with one study claiming the token was used to prop up Bitcoin during major price drops in its 2017 monster rally.
“Tether is a massive problem,” Carol Alexander, professor of finance at the University of Sussex, told CNBC. “The regulators don’t seem to be able to stop them so far. “
“Traders need Tether to open accounts and trade. Or other cryptocurrencies. But since most of the big dealers are based in the US, Tether is the obvious choice. “
“Meme coins” and cheating
Rising speculation in the crypto markets could pose another risk to Bitcoin.
Dogecoin, a cryptocurrency that started as a hoax, skyrocketed to record highs earlier this year as a growing number of retail investors piled into digital assets in search of oversized profits.
At one point, Dogecoin was worth more than Ford and other big US companies, thanks in no small part to the support of celebrities like Musk. Since then, its value has depreciated significantly.
Elsewhere in the crypto market, a decentralized financial or DeFi token called Titan crashed to zero. The self-made billionaire investor Mark Cuban was the owner.
“Another concern is the number of scams that have emerged during the year,” said Yu of StormX. “With certain meme coins, we’ve seen a lot of pump-and-dump activity and seen retail investors get burned.”
“Whenever the retail trade is burned, the government intervenes. And if things are overregulated to a point, as we saw with 2018 and ICOs (Initial Coin Offerings), the industry as a whole could be negatively impacted. “