If you’re new to cryptocurrency and accustomed to the price action of stocks, bonds, exchange-traded funds (ETFs) or other similar assets, the crypto market crash in May probably looked terrifying. Bitcoin, the world’s leading crypto in terms of market capitalization, fell more than 40% in 15 days. Many cryptos experienced even steeper drops like Ethereum, the 2nd-largest crypto by market capitalization, which plummeted almost 50% in 12 days. Anyone who has been watching cryptocurrencies for at least a few years shouldn’t be so shocked.
High volatility is part of the nature of the cryptocurrency market for many reasons. Each cryptocurrency generally has less available liquidity than many traditional financial markets allowing prices to move faster. News can also play a much greater role in the price of cryptos than other assets. For example, when a coin is banned in a country or a popular celebrity no longer supports it, adoption often decreases and investors sell off rapidly. Also, the stock market has an unfair advantage in volatility because it has regulations that help slow massive price movements. So-called circuit breakers automatically suspend trading on a stock or ETF for a set period of time if it rises or drops too quickly.
It’s important to remember that every time Bitcoin or Ethereum has fallen in the past they eventually recovered and reached new all-time highs. Volatility can (and probably should) be scary to the average investor, but it’s nothing new for crypto and it seems unlikely that this crash will be any different from the last. However, it’s still possible that Bitcoin and Ethereum will never recover to all-time highs.
What is Bitcoin?
Bitcoin is a decentralized digital currency or cryptocurrency, accessible to anyone with an internet connection. Users can send Bitcoin online between each other without involving a bank or another intermediary. Bitcoin is underpinned by a decentralized public ledger called a blockchain that records all transactions on it for everyone to see.
The network verifies and processes transactions using its consensus mechanism, Proof of Work (PoW). In PoW, network participants called miners solve complex puzzles with expensive hardware to add a block of transactions to the blockchain. Each block takes into account every single block added before it, hardening previous transactions to tampering. When miners find a solution and add a block, they are rewarded with a certain amount of Bitcoin and the fees accumulated from all transactions included in the block.
The price of the coin has exploded over the past few years, increasing the incentive for solving the puzzles. The difficulty of these puzzles is extremely important in securing PoW blockchains and it has risen dramatically for Bitcoin because of skyrocketing competition among miners. If it only took a small amount of computing power to solve them, it would be easier to take over the network. Anyone with more than 51% of the network’s computing power could theoretically take over the network, verifying only the transactions they want to verify. This is extremely unlikely to happen with Bitcoin because it is prohibitively expensive to reach that 51% mark.
Scarcity is likely one of the vital drivers of Bitcoin’s value and widespread adoption. Unlike Bitcoin, many fiat currencies can almost be printed at will by national governments (a noticeable exception is the euro), leading to differing rates of inflation. Bitcoin has a hard cap of 21 million on its supply written into its source code, meaning that the maximum amount of it in existence will probably be 21 million. It’s theoretically possible that this could be changed through Bitcoin’s decentralized governance. However, there aren’t any strong incentives to do so for the people who could make the change.
Once the supply hits its cap (which may not happen until about 2140), miners will earn transaction fees but no block rewards, decreasing revenue. If a conspiring group of miners was able to reach 51% of the computing power of Bitcoin, they could increase the maximum supply. You might think that miners would want to do this so that they could resume earning block rewards, but it would obliterate the idea that Bitcoin is scarce. The cost of attaining the 51% would be enormous and the price of Bitcoin would almost certainly nosedive as soon as the change goes live.
History of Bitcoin
In the throes of the 2008 financial crisis, an anonymous visionary going by the pseudonym Satoshi Nakamoto published a white paper called Bitcoin: A Peer-to-Peer Electronic Cash System. The paper started a slowly growing revolution to remove the central 3rd party from finance. Likely the greatest invention in the paper is blockchain technology that removes the need to trust finicky 3rd parties in transactions. Instead of putting their faith in financial institutions like banks or central governments, Bitcoin users trust the technology and that their transactions will be processed fairly and safely.
On May 22, 2010, an early Bitcoin investor named Laszlo Hanyecz made the first purchase with the cryptocurrency. He paid 10,000 Bitcoin, worth about $41 then — $310 million now — for 2 large pizzas. Since 2010, Bitcoin has seen dramatic growth in market cycles. Its price becomes overvalued, eventually crashes and then undergoes a long period of accumulation before the cycle repeats.
Many investors consider 2015 as the start of the most recent full cycle when Bitcoin was about $230. The cycle didn’t push Bitcoin to its then all-time high, near $20,000, until the end of 2017. It took another year for it to reach its local minimum of about $3,000 in December 2018.
Luckily for Bitcoin investors, that low hasn’t been seen since and the price rose to over $64,000 in April 2021. At the time of writing, Bitcoin’s price is hovering around $31,000 and the cycle (if it’s even over) may not meaningfully repeat for a year or more. No one is certain of what will happen next or if Bitcoin will follow these cycles in the future.