Virtual currency Bitcoin is barely five years old, and the free-floating and non-government-encumbered asset has already seen huge price swings. First introduced in 2009, it took 1300 Bitcoins to equal one dollar. By May 2011, the new virtual currency had reached parity with the dollar. At the peak of the Bitcoin frenzy in late November 2012, the exchange rate reached 1242 dollars per Bitcoin.
As of January 14, 2015, the price of the virtual currency had dropped to around 180 dollars per Bitcoin.
Recent catalysts for Bitcoin crash
Yahoo Finance contributor Brian Kelly wrote a post on January 14th trying to identify the various catalysts that have led to the recent collapse in the price of Bitcoin.
A large Bitcoin exchange, BitStamp, suffered a major hack last week. More than $5 million in Bitcoins was stolen by the hackers. That said, BitStamp shut down operations as soon as possible, and repaid every investor before coming back online with very high security. Kelly notes that this incident had to be a big blow to confidence of investors, and likely led to some investors liquidating Bitcoin holdings.
Bitcoins are discovered by “mining” mathematical algorithms. CEX is a very large mining operations that manages the GHash mining pool and sells mining contracts. However, the recent Bitcoin price slump has made these mining contracts unprofitable, so CEX has ceased mining operations. Kelly notes the owners of these contracts probably “liquidated in favor of fiat currency – weighing on the price of bitcoin.”
Russian legal situation
Russia has been saying it was going to make Bitcoin illegal for almost a year now, but there had been no concrete action from the Russian government until this weekend. In fact, Bitcoin had recently become a popular investment in the country as the Russian currency collapsed. Some analysts opined that rich Russians were getting money out of Russia Bitcoins. As of a few days ago, however, the Russian Bitcoin community has been abuzz that some Bitcoin websites have been banned.
Negative Feedback Loop
Kelly argues that all of these elements are coming together to create negative feedback loop. He points out that this negative feedback phenomenon is not rare in financial markets. But until some other catalyst forms to break the negative loop, Bitcoin prices will remain down.
He also points out it is almost a certainty that Bitcoin will continue to “experience irrational bubbles, crashes and feedback loops” as this seems to be human nature in relation to markets.
Kelly notes: “Like any market, Bitcoin is an open natural system and is subject to the panic and euphoria that engulf all financial markets from time to time. It’s dismal, it’s depressing and…it’s normal.”