This article was written exclusively for Investing.com
- Cryptos making a comeback
- Risk #1: Government bans
- Risk #2: Regulation
- Risk #3: Taxation
- Risk #4: Heart-stopping turbulence with a capital 'T'
The cryptocurrency asset class appears to have bottomed after a stunning correction that took Bitcoin and Ethereum from record highs in mid-November to below half the values at the high in January. Explosive and implosive price action is nothing new for the asset class. It has gone from feast to famine, back to feast and back to famine over the past years.
Indeed, cryptocurrencies give new meaning to the notion of price volatility. Before Bitcoin burst on the scene, market participants considered commodities as alternative assets with head-spinning volatility. Cryptocurrencies ushered in a new era, where market participants have embraced price variance.
The success of casinos hinges on their profiting from gamblers’ quest for a jackpot. State-run lotto contests do the same, advertising: “All you need is a dollar and a dream.” That reliable, and all-too-human impulse is evident in the digital currency space as well.
Tales of a $10 investment in Bitcoin in 2010—at five cents per token—ballooning to $8 million in value at $40,000 per token in 2021 have been enough to give birth to more than 17,400 new cryptocurrencies as of Feb. 15 and rising.
As the cryptos corrected from the mid-November peaks, some speculative froth evaporated until late January. However, it appears to be back with a vengeance in mid-February as investors in Bitcoin, Ethereum and many other cryptos are back to bullish and feasting mode.
Cryptos Making A Comeback
On Nov. 10, the bearish key reversal patterns in Bitcoin and Ethereum caused the leading cryptocurrencies to lose more than half their value. After reaching bottoms in January, they have both recovered, consolidating well above the lows in mid-February.
Source: CQG
The chart shows the bearish reversal on Nov. 10 that took February Bitcoin futures from a high of $70,330 to a low of $32,945 per token on Jan. 24. The 53.2% decline ran out of selling, and Bitcoin recovered to just below the $44,000 level at time of writing on Feb. 17.
Bitcoin futures have been trading between $41,420 and $45,905 since Feb. 7, making higher highs as a recovery is under way. The critical level to watch is at $51,640, the 50% retracement of the move from the November high to the January low.
Source: CQG
February Ethereum futures fell from $4,945.75 in mid-November to $2,164.50 in late January, a 56.2% decline. At the $3,000 level on Feb. 17, Ethereum remains below the 50% retracement level, which sits at the $3,555 level. Since Feb. 7, Ethereum futures have consolidated between $2,831.50 and $3,292 per token.
If the past price action is a guide, Bitcoin, Ethereum and many of the other more than 17,560 cryptocurrencies could be ready for another explosive move that takes the tokens to higher highs.
Meanwhile, any investor or speculator ready to dip a toe into the cryptocurrency asset class much watch four crucial risks over the coming weeks and months.
Risk #1: Government Bans
The geopolitical landscape has become highly turbulent and volatile. The U.S. and Europe consider Ukraine Eastern Europe, while Russian President Vladimir Putin believes it is Western Russia. Current Russian demands that Ukraine never become a NATO member, along with 130,000 troops massing on Ukraine’s border, could lead to an incursion or war in Europe.
China and Russia have agreed to increased cooperation, with China supporting Russia over Ukraine. China has pledged to help Russia if western sanctions attempt to cripple the Russian economy, rendering any sanctions toothless. Iran and North Korea remain clear and present dangers on their own with growing nuclear capabilities.
While the geopolitical landscape supports cryptocurrencies’ global reach, we could see government bans on crypto trading and investing. Though any bans may not stop the asset class from operating via secured channels on the internet, such clampdowns would slow the asset class's growth.
Risk #2: Regulation
The SEC, CTFC and legislators are addressing cryptocurrencies with new regulations in the U.S., while European regulators are also addressing the asset class. While they purport to be “protecting the public,” the underlying motivation is controlling the money supply.
Central banks and governments control purse strings, so they can print legal tender and withdraw it from the system to manage economies. The ideology that underpins cryptocurrencies is opposed to government control, as values are based only on buying and selling in a transparent marketplace, returning power to individuals.
Moreover, traditional banking and finance institutions view cryptos as a threat to their profits and balance sheets. The greater the number of people who hold cryptos in computer wallets, the less they need traditional banks and finance companies.
Regulation will tighten in the cryptocurrency arena over the coming year, which could thwart the libertarian form of money growth. Cryptos threaten government control and traditional money and banking businesses. The front lines in the crypto debate are about controlling the money supply. Monetary and fiscal policies support political agendas.
Risk #3: Taxation
Taxes are a critical government tool that could impact cryptocurrencies. The U.S. Internal Revenue Service and tax authorities worldwide are developing policies to address the burgeoning asset class.
Taxation policies can be instruments that help or hinder markets. Politicians, regulators and banking lobbyists could turn to taxation as a silver bullet that addresses the crypto threat to government control.
Risk #4: Heart-Stopping Turbulence With A Capital ‘T’
The potential for financial rewards comes with commensurate risks. The incredible price variance in the cryptocurrency asset class has made it a speculator’s dream albeit a turbulent one, and it can also be an investor’s nightmare when buying at the wrong level. Investors who got in early can ride the waves, watching their digital assets move higher and lower like yo-yos. However, anyone who invested in Bitcoin, Ethereum or other cryptocurrencies in October or early November experienced heart-stopping losses.
High volatility creates turbulent risk with a capital T. I have been trading in markets for more than four decades and have never witnessed an asset class quite like the crypto arena. I was a commodity trader for many years, which is an arena that is rife with price variance. However, commodities pale in comparison to cryptos when it comes to price action.
Bitcoin, Ethereum and other digital asset class members appear to have found at least temporary bottoms. That means many investors and speculators will begin to buy in anticipation of another explosive rally.
While the potential for a return to the highs is rising, only invest capital you are willing to lose, as every penny invested in cryptos is at risk of a total loss. Keep in mind that hedge fund manager Ray Dalio said in 2021 that governments have the power to “kill” the asset class. Of course, that hasn't yet happened, but when it comes to cryptos, buyers must be prudent and understand the risks that are always a function of potential rewards.