2022 was a bad year for cryptocurrencies. I discussed how the blockchain foundation of transactions can’t be hacked, but this does not reach to the companies who have created exchanges and are responsible for how currencies are sent from one place to another. An exchange is where people hold their currency (kind of like Etrade or Robinhood). They act as a holding spot and many allow you to convert one coin to another. Unfortunately, if the systems at the exchange are not protected, hackers gain access to the exchanges or they can intercept currencies from one spot to another and redirect coins to their own accounts.
In addition to hackers able to access exchanges, what we saw in 2022 were exchanges just being bad actors. In the case of Luna, they had a stable coin that is supposed to be worth $1 and should have had assets to back up the $1 price. In other words, if you issue $1 million in coins and tell people that the coins are worth $1 each, you should have $1 million in assets to back up the $1 million in coins that are out there. Luna did not have any assets. Their coin was backed by the value of other coins and an algorithm that was not supposed to fail. Well, when a company came out against the stable and started withdrawing their coins, a lot of other people started to withdraw their coins causing a run on the coin and the value dropped to almost nothing. This shook the market and all coins started to drop in value.
Cryptocurrencies have experienced several significant price crashes throughout their history, and there is rarely a single cause for these events. However, some of the common factors that have contributed to cryptocurrency crashes in the past include:
- Market speculation and hype: Cryptocurrencies are a relatively new asset class, and their value is largely determined by market speculation and hype. When investors become overly optimistic about the potential returns of cryptocurrencies, prices can rise rapidly, creating a bubble. Eventually, the bubble bursts, and prices come crashing down as investors realize that the assets were overvalued.
- Regulatory actions: Cryptocurrencies are often viewed as a threat by governments and financial institutions because they operate outside of traditional banking systems. As a result, governments may take regulatory actions that negatively impact the value of cryptocurrencies. For example, China’s recent crackdown on Bitcoin mining and trading caused a significant drop in the cryptocurrency’s value.
- Security concerns: Cryptocurrencies are vulnerable to hacking and fraud, and there have been several high-profile security breaches in the past. When investors lose confidence in the security of a particular cryptocurrency, they may sell their holdings, causing prices to drop.
- Market volatility: Cryptocurrencies are known for their extreme volatility, with prices fluctuating wildly in short periods. This volatility can be caused by a variety of factors, including news events, market sentiment, and changes in supply and demand.
It’s important to note that cryptocurrency crashes are a natural part of the market cycle, and they are not necessarily a sign of a long-term decline in value. As the cryptocurrency market matures, it may become more stable and less susceptible to extreme price swings.