Bitcoin plunged by more than $1,000 (£740) on Thursday after South Korea said it was planning a crackdown on trading in the digital currency in the latest of a string of warnings for investors.
It dropped to about $13,500 after trading at about $15,400 on Wednesday. The dip was seen as a further illustration of bitcoin’s volatility.
The cryptocurrency has surged in value this year by more than 900%, becoming one of the biggest stories in finance amid a slew of warnings of a pending market crash.
Bitcoin recovered ground later on Thursday and was trading at about $14,000 at 5.30pm UK time.
South Korea, which is one of the biggest markets in the world for bitcoin, said it was preparing a ban on opening anonymous cryptocurrency accounts and new legislation to enable regulators to close coin exchanges if they felt there was a need to do so.
Bitcoin is a 'cryptocurrency' – a decentralised tradeable digital asset. Invented in 2008, you store your bitcoins in a digital wallet, and transactions are stored in a public ledger known as the bitcoin blockchain, which prevents the digital currency being double-spent.
Cryptocurrencies can be used to send transactions between two parties via the use of private and public keys. These transfers can be done with minimal processing cost, allowing users to avoid the fees charged by traditional financial institutions - as well as the oversight and regulation that entails. The lack of any central authority oversight is one of the attractions.
This means it has attracted a range of backers, from libertarian monetarists who enjoy the idea of a currency with no inflation and no central bank, to drug dealers who like the fact that it is hard (but not impossible) to trace a bitcoin transaction back to a physical person.
The exchange rate has been volatile, with some deeming it a risky investment. In January 2021 the UK's Financial Conduct Authority warned consumers they should be prepared to lose all their money if they invest in schemes promising high returns from digital currencies such as bitcoin.
In practice it has been far more important for the dark economy than it has for most legitimate uses. In November 2021 it hit a record high of more than $68,000, as a growing number of investors backed it as an alternative to other assets during the Covid crisis.
Bitcoin has been criticised for the vast energy reserves and associated carbon footprint of the system. New bitcoins are created by “mining” coins, which is done by using computers to carry out complex calculations. The more bitcoins that have been "mined", the longer it takes to mine new coin, and the more electricity is used in the process.
According to Reuters, the South Korean government issued a statement saying it had “warned several times that virtual coins cannot play a role as actual currency and could result in high losses due to excessive volatility”.
The move came less than two weeks after the high-profile insolvency of one of the country’s digital currency exchanges, after the Seoul-based platform was hit by hackers for a second time.
The exchange, called Youbit, shut down after losing 17% of its assets in a cyber-attack which was later blamed on North Korean hackers. The incident followed several other attacks against cryptocurrency platforms, such as a hack earlier in the month against the cryptomining marketplace NiceHash, which lost about 4,700 bitcoins in the attack.
The crackdown in South Korea comes amid repeat warnings from leading figures in finance and some of the world’s top economists, who have said the currency is a vehicle for fraudsters and drug dealers. There are also fears that its rapid increase in value this year could quickly unwind, causing severe losses for investors.
Sir Howard Davies, who chairs RBS, has likened investing in bitcoin to Dante’s Inferno – “Abandon hope all ye who enter here” – while Jamie Dimon, the head of JP Morgan, has said bitcoin could potentially be worse than the tulip mania of the 17th century, when bulb prices rose vertiginously before crashing.
However, several leading academics have said bitcoin poses no threat to the stability of the financial system, as its total value stands at about $240bn, paling in comparison with the total value of global shares at almost $80tn.
Companies are also exploring ways to exploit blockchain – which is the technology underpinning bitcoin and works by securely encrypting information – to speed up everything in business from making payments to transferring data and contracts.
Bitcoin rose to nearly $20,000 a week before Christmas, following the introduction of derivatives trading for major investment firms on the Chicago Mercantile Exchange, which enabled hedge funds to place bets on future prices. However, it then lost 25% of its value on 22 December, before recovering earlier this week and then slumping again on Thursday.
While some have said more investors in the market could help support higher valuations, the currency is on a jittery run.
Craig Erlam, senior market analyst at trading firm Oanda, said the recent fall in value could have made speculators more wary of the potentially negative news from Korea for its market price.
“We saw plenty of this in reverse on the way up, with positive news triggering significant rises and negative news being brushed aside. It wouldn’t surprise me if we see prices heading back below $10,000 before they find their feet again,” he said.
Digital currencies have grabbed the attention of global regulators this year as a consequence of bitcoin’s rapid price growth, gaining in value from about $1,000 at the beginning of 2017. Other cryptocurrencies such as Ethereum, Ripple and Litecoin have also gained in value this year.
Closer control of digital currencies by financial watchdogs could result in further volatility for bitcoin, as part of its attraction among supporters has been the lack of government and central bank oversight.
The UK’s Financial Conduct Authority has issued a warning about investing in initial coin offerings, which use digital tokens to raise funds for startup businesses and projects.
