After bitcoin’s wild first half, these are the 5 biggest risks ahead

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Bitcoin got off to a solid start in 2021, hitting an all-time high of nearly $ 65,000 in April. But the digital currency ended the first half of the year down about 47% from its record high, and a series of looming risks could result in more pain down the road.

While proponents seem to be holding on to Bitcoin for now, other investors are wary of the huge volatility in the market and what it means for their portfolios. With that in mind, here are five of the biggest risks cryptocurrency faces as it enters the second half of the year.

Regulation

One of the biggest risks for Bitcoin right now is regulation.

In recent weeks, China has cracked down on its cryptocurrency industry, shutting down energy-intensive cryptocurrency mining operations and ordering major banks and payment companies like Alipay not to do business with cryptocurrency companies.

Last week, the global crackdown on cryptocurrencies spread to the UK, where regulators banned Binance, a leader in digital currency exchange, from conducting regulated activities.

Simon Yu, co-founder and CEO of StormX, the crypto money-back startup, told CNBC that China’s moves should be viewed as a “positive” for bitcoin and other cryptocurrencies such as ether as they will lead to further decentralization. However, he added that “excessive regulation” of cryptocurrencies in the United States could be a problem.

“As a country, the US has too many departments that regulate it from different angles – is crypto a security? A commodity? A property? ” Yu said. “Until now, the United States has not figured out how to properly regulate the industry, often leading to decisions that are difficult for cryptocurrencies to operate.”

US Treasury Secretary Janet Yellen and other officials recently warned about the use of cryptocurrencies for illicit transactions.

Last year, the administration of former President Donald Trump proposed an anti-money laundering rule that would require people who keep their cryptocurrencies in a private digital wallet to undergo identity checks if they conduct transactions of $ 3,000 or more.

“We have long warned that change in investor sentiment or regulatory crackdowns could blow up bubble-like crypto markets,” UBS wrote in a note this week.

Volatility

Another big risk is extreme and persistent changes in the price of bitcoin and other digital currencies.

Bitcoin rallied to an all-time high of around $ 64,829 in April this year, the day of the successful debut of crypto exchange Coinbase. It then fell as low as $ 28,911 in June, briefly sliding below $ 30,000 and turning negative for the year. It has since risen above $ 34,000 again.

Bitcoin bulls see it as a kind of “digital gold,” an asset uncorrelated to the broader marker that could provide sizable returns in times of economic turmoil. But while volatility can be good when the price of an asset rises, it is both ways.

While you would have doubled your money if you bought bitcoin in January and cashed it in April, today those year-to-date returns would be 18%. Still, it is above the performance of the S&P 500 index, which is up 16% since the beginning of the year. And in the last 12 months, the price of bitcoin has more than tripled.

“The limited and highly inelastic supply in individual cryptocurrencies can exacerbate volatility,” says UBS. “The limited use in the real world and the extraordinary volatility of prices also indicate that many buyers are looking for speculative profits.”

Meanwhile, the tendency for traders who have made highly leveraged bets on bitcoin to exit the market has led to intense price fluctuations this year.

While ongoing volatility might put off some investors, Ross Middleton, CFO at decentralized finance platform DeversiFi, said volatility itself is not a barrier to institutional adoption.

The volatility “can actually be a major draw, as the potential for large price movements means that the funds can make significant profits with a relatively small allocation compared to their overall portfolio size,” he told CNBC.

“The longer Bitcoin moves sideways in the $ 30- $ 40k range,” Middleton added, “the greater the perceived ‘base build’ and the sooner new capital will flow into both the asset and the more crypto market. large”.

Environmental concerns

Musk’s electric car firm surprised both fans and skeptics of bitcoin this year when it bought $ 1.5 billion in the digital currency and began accepting it as a payment method. But it subsequently rocked the crypto markets after deciding to stop bitcoin payments due to the currency’s “crazy” energy use and dependence on fossil fuels.

It raises some questions for asset managers who are under increased pressure to limit their investments to ethically conscious assets.

“It may at least discourage some investors from holding Bitcoin,” Citi analysts wrote in a research note earlier this year, adding that it could also “spur government intervention to ban mining, as seen in parts of China. ”.

Stablecoin scrutiny

So-called stablecoins, whose prices are meant to be pegged to real-world assets like the US dollar, are also facing increasing scrutiny.

Last week, the chairman of the Federal Reserve Bank of Boston, Eric Rosengren, said that tether, a stablecoin that is among the world’s largest digital currencies, was a risk to the stability of the financial system.

Tether maintains that each of its tokens is backed 1: 1 by US dollars held in a reserve, with the idea that this will keep the price stable. Cryptocurrency investors often use tether to buy cryptocurrencies, as an alternative to the dollar, but some investors are concerned that the issuer of tether may not have enough dollar reserves to justify its peg to the dollar.

In May, the company behind tether broke down the stablecoin reserves, revealing that around 76% was backed by cash and cash equivalents, but just under 4% of that was real cash, while around 65% was commercial paper, a form of short-term debt.

Tether has been compared to traditional money market funds, but without regulation, and, with tokens in circulation worth nearly $ 60 billion, it has more deposits than many US banks.

There have long been concerns about whether tether is being used to manipulate bitcoin prices, with one study claiming that the token was used to prop up bitcoin during key price drops in its monster rally of 2017.

“Tether is a huge problem,” Carol Alexander, a finance professor at the University of Sussex, told CNBC. Regulators seem unable to stop them so far. “

“Traders need a tether to open accounts and trade. Or other crypto. But since most of the big merchants are based in the US, tethering is the obvious choice. “

‘Meme coins’ and scams

Increasing speculation in the crypto markets could prove to be another risk for Bitcoin.

Dogecoin, a cryptocurrency that started out as a joke, skyrocketed earlier this year to record highs as a growing number of retail investors piled on digital assets in search of gargantuan profits.

At one time, dogecoin was worth more than Ford and other major American companies, thanks in large part to the endorsement of celebrities like Musk. Its value has depreciated significantly since then.

Elsewhere in the cryptocurrency market, a decentralized finance token, or DeFi, called the Titan crashed to zero. Self-made billionaire investor Mark Cuban was a starter.

“Another concern is the number of scams that have surfaced during the year,” said Yu of StormX. “With certain meme coins, we’ve seen a lot of pump and dump activity and we’ve seen retail investors burn out.”

“Every time retail is burned, the government intervenes. And if things are over-regulated to some degree, as we’ve seen with 2018 and ICOs (initial coin offerings), the industry as a whole could be adversely affected. “

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