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The Cryptocurrency Crash Is Here, and This Is What's Most Interesting About It

Sean Williams, The Motley Fool

In 2017, cryptocurrencies could seemingly do no wrong. In fact, virtual currencies delivered what could very well be described as the single greatest year in the history of any asset class. When 2017 began, the combined value of all digital currencies was less than $18 billion. By year's end, however, the aggregate market cap of cryptocurrencies hit $613 billion -- a better than 3,300% increase. This is the type of return that would have taken the stock market decades to generate.

And it technically didn't stop there. By the end of the first week of January 2018, cryptocurrencies hit an all-time high of $835 billion.

A physical gold bitcoin surrounded by a plunging chart, binary code, and circuitry.

Image source: Getty Images.

Buckle up: The cryptocurrency crash has arrived

Then the wheels fell off the wagon, the party candles blew out, and Tom Petty's "Free Fallin'" got stuck on repeat in the CD player. During the overnight hours on Tuesday, Feb. 6, the combined market cap of cryptocurrencies tumbled to their lowest point since Nov. 25, 2017, hitting $278.5 billion. In less than a month, cryptocurrencies have lost two-thirds of their value.

With the exception of stable coins like Tether, it's been a pretty even drubbing across the board. Bitcoin, the face of the virtual currency rally and the world's most popular virtual token, has retraced from nearly $20,000 per coin on Dec. 17, 2017, to almost $6,100 per coin. What had been a market cap of more than $330 billion is now threatening to fall under $100 billion.

The rout is on with Ethereum, Ripple, and Litecoin, too. Having hit highs of $1,432.88, $3.84, and $375.29, respectively, Ethereum, Ripple, and Litecoin have now shed 59%, 84%, and 70% of their market value. Ripple's decline is particularly harsh, with the financial services-focused cryptocurrency collapsing from a nearly $150 billion market cap to just $24 billion.

A person using a pin to pop a bubble with a dollar sign inside of it.

Image source: Getty Images.

There are no shortage of reasons behind the crypto crash

Why the sudden train wreck, you wonder?

To begin with, certain countries and businesses have been tightening the regulatory noose around bitcoin and cryptocurrencies as a whole. For instance, South Korea, which is one of the most prominent markets for global bitcoin trading, recently announced new regulations that require investor transparency when trading in bitcoin. New funds can only be invested in cryptocurrencies in South Korea if they're linked to a verified bank account -- and it's the banks' responsibility to verify users' identities before that link is allowed. Given that anonymity is a major selling point of cryptocurrencies as a whole, this development isn't being viewed as a positive.

Just as worrisome, a number of global banks purportedly won't be supporting cryptocurrency transactions with their credit cards, according to a Bloomberg report. The banks -- Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), and Citigroup (NYSE: C) -- suggest that purchasing cryptocurrencies with credit creates all sorts of hassles if the consumer can't repay the loan or if stolen cards are used to purchase untraceable virtual coins. With lending rates rising, Bank of America, JPMorgan Chase, and Citigroup are looking out for their own financial safety and that of their customers. 

Unrealistic expectations surrounding blockchain technology may also be to blame. Blockchain is the digital, distributed, and decentralized technology that underpins virtual currencies and is responsible for recording all transactions without the need for a financial intermediary, like a bank. The incorporation of blockchain is expected to expedite the settling of transactions, lower transaction fees, and improve network security. It has applications beyond finance as well, such as Internet of Things network management and supply chain management, among others.

Bicycle chains with binary code linked together to represent blockchain.

Image source: Getty Images.

Unfortunately, blockchain has been around for nearly a decade and is only now being tested in demos and small-scale projects. Even in instances where major partners have stepped up to test the blockchain of a major cryptocurrency, we're not talking about anything more than internal testing or very limited small-scale projects. At this rate, even if blockchain is a success, it could take years before it's regularly integrated by businesses. This realization could be sacking cryptocurrency valuations.

The most interesting aspect of the cryptocurrency crash

However, what's truly noteworthy about the bubble popping for virtual currencies is that it's occurring at the exact same time that the U.S. stock market is rolling over.

On Friday and Monday, the Dow Jones Industrial Average (DJINDICES: ^DJI), America's most iconic stock index, fell 666 and 1,175 points, respectively, representing what is now the seventh-highest and biggest point declines in its almost 122-year history. Fears about exceptionally strong economic growth leading to higher inflation and quicker interest rate hikes primarily sparked the sell-off, but computer-driven selling has also been blamed.

In 2017, cryptocurrencies were often viewed as a store of value with the U.S. dollar swooning and as an alternative to traditional equities in the stock market. Last year, trusting in cryptocurrencies worked well. Lately, though, it's been a different story. Even with the Dow tumbling more than 2,200 points since Jan. 26, cryptocurrencies have continued to plunge. In other words, despite fear returning to the stock market, investors aren't turning to digital currencies as a safe store of their wealth. This is the first time we've really witnessed investors turning their backs on cryptocurrencies as a whole, and it could represent a major shift in retail investor sentiment.

A businessman holding his hands up as if to say no thanks.

Image source: Getty Images.

Remember, unlike with traditional equities, cryptocurrencies are mostly controlled by retail investors. Institutional investors simply aren't willing to buy or sell digital currencies on decentralized exchanges. Retail investors are far likelier to allow their emotions to get the best of them, which often means overshooting to the upside, and the downside. With cryptocurrencies continuing to tumble in unison with the stock market, it appears to suggest that retail investors are feeling decidedly negative about altcoins.

My suggestion now is exactly as it has been for months: Keep your distance. While blockchain offers plenty of promise, it's a technology that's probably years away from broader implementation. That portends the possibility of more pain for cryptocurrencies and their investors.

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Sean Williams owns shares of Bank of America, but has no position in any cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.