Even by Bitcoin's standards, Wednesday was pretty wild.
The price of the famously volatile digital currency fell nearly 30 per cent at one point after the China Banking Association warned member banks of the risks associated with digital currencies. The decline narrowed to below 10 per cent in the afternoon, but Bitcoin had still lost about US$70 billion in market value in 24 hours.
Bitcoin has lost about 38 per cent of its value since April 13, when it hit a high of more than $64,600. The China warning was just the latest headwind: Before Wednesday, Tesla's decision to not accept the digital currency as payment for cars — after it said it would — and murmurings in Washington about tighter regulation of digital currencies had put pressure on Bitcoin. The price is still up about 31 per cent in 2021 and nearly 300 per cent from a year ago.
Here's a look at Bitcoin and digital currencies in general:
How Bitcoin works
Bitcoin is a digital currency that is not tied to a bank or government and allows users to spend money anonymously. The coins are created by users who "mine" them by lending computing power to verify other users' transactions. They receive Bitcoins in exchange. The coins also can be bought and sold on exchanges with US dollars and other currencies. Some businesses take Bitcoin as payment, and a number of financial institutions allow it in their clients' portfolios, but overall mainstream acceptance is still limited.
Bitcoins are basically lines of computer code that are digitally signed each time they travel from one owner to the next. Transactions can be made anonymously, making the currency popular with libertarians as well as tech enthusiasts, speculators — and criminals.
Bitcoins have to be stored in a digital wallet, either online through an exchange like Coinbase, or offline on a hard drive using specialised software. According to Coinbase, there are about 18.7 million Bitcoins in circulation and only 21 million will ever exist. The reason for that is unclear, and where all the Bitcoins are is anyone's guess.
What happened to the price?
On Wednesday, a statement posted on the Chinese Banking Association's website said financial institutions should "resolutely refrain" from providing services using digital currencies because of their volatility.
Virtually every cryptocurrency fell after the industry group's statement.
As of 4.15pm eastern time Wednesday, Bitcoin was down more than 7 per cent at around $40,310 per coin. Most cryptocurrencies lost between 7 per cent and 22 per cent of their value and shares of Coinbase dropped 5.4 per cent.
It's not unusual for the value of Bitcoin to change by thousands of dollars in a short time period, though swings totaling around $20,000 in one day are extreme. On the last trading day of 2020, Bitcoin closed just under $30,000. In mid-April, it flirted with $65,000.
Doesn't Elon Musk have a role here?
Yes, and a fairly big one. Musk announced in February that his electric car company Tesla had invested $1.5 billion in Bitcoin. In March, Tesla began accepting Bitcoin as payment. Those actions contributed to the run-up in Bitcoin's price, and Musk also promoted the digital currency Dogecoin, which also spiked in value.
However, Musk reversed course in just a short time, saying last week that Tesla would stop accepting Bitcoin because of the potential environmental damage that can result from Bitcoin mining. The announcement sent Bitcoin falling below $50,000 and set the tone for the big pullback recently in most cryptocurrencies.
Musk tweeted at 3am NZST to indicate Tesla was standing firm despite the crash.
A number of Bitcoin fans pushed back on Musk's reasoning. Fellow billionaire Mark Cuban said that gold mining is much more damaging to the environment than the mining of Bitcoin.
A 2019 study by the Technical University of Munich and the Massachusetts Institute of Technology found that the Bitcoin network generates an amount of CO2 similar to a large Western city or an entire developing country like Sri Lanka. But a University of Cambridge study last year estimated that on average, 39 per cent of "proof-of-work" crypto mining was powered by renewable energy, primarily hydroelectric energy.
But some companies are still using Bitcoin
The digital payment company Square and its CEO Jack Dorsey — also the CEO of Twitter — have been big proponents of Bitcoin. Overstock.com also accepts Bitcoin, and in February, BNY Mellon, the oldest bank in the US, said it would include digital currencies in the services it provides to clients. And Mastercard said it would start supporting "select crypto currencies" on its network.
Bitcoin has become popular enough that more than 300,000 transactions typically occur in an average day, according to Bitcoin wallet site blockchain.info. Still, its popularity is low compared with cash and credit cards.
Is there scepticism around Bitcoin?
Yes, plenty of it. Tracking Bitcoin's price is obviously easier than trying to figure out its value, which is why so many institutions, experts and traders are skeptical about it and cryptocurrency in general. Digital currencies were seen as replacements for paper money, but that hasn't happened so far. Federal Reserve Chair Jerome Powell has said the central bank prefers to call crypto coins "crypto assets", because their volatility undermines their ability to store value, a basic function of a currency.
While some banks and financial services companies are getting in on it, others are staying away.
Could a digital currency selloff cause widespread damage?
Regulators aren't very worried about a possible crash in digital currencies dragging down the rest of the financial system or economy.
Even with the recent sell-off, digital currencies have a market value of about $1.72 trillion, according to the website coinmarketcap.com. But that pales compared with the $46.9 trillion stock market, $41.3 trillion residential real estate market and nearly $21 trillion Treasury market at the start of the year.
The European Central Bank said Wednesday that the risk of cryptocurrencies affecting the financial system's stability looks "limited at present." In large part, that's because they're still not widely used for payments and institutions under its purview still have little exposure to crypto-linked instruments.
Earlier this month, the Federal Reserve said a survey of market contacts found roughly one in five cited cryptocurrencies as a potential shock to the system over the next 12 to 18 months. That's a turnaround from the fall, when a similar survey found none mentioning cryptocurrencies.
How much oversight is there?
Washington officials have been talking about regulating digital currencies more, and worries about a heavier hand have played a role in the recent swoon in prices.
Gary Gensler, who took over as chairman of the Securities and Exchange Commission last month, has said that cryptocurrency markets would benefit from more oversight to protect investors.
In a hearing before the House's financial services committee earlier this month, Gensler said neither the SEC nor the Commodity Futures Trading Commission, which he used to head, has a "regulatory framework" for trading on cryptocurrency exchanges yet. He said he thought Congress would ultimately have to address it because "there's really not protection against fraud or manipulation".
How Bitcoin came to be
It's a mystery. Bitcoin was launched in 2009 by a person or group of people operating under the name Satoshi Nakamoto. Bitcoin was then adopted by a small clutch of enthusiasts. Nakamoto dropped off the map as Bitcoin began to attract widespread attention. But proponents say that doesn't matter: The currency obeys its own internal logic.