What's behind the plunge in bitcoin?

Amid some roller-coaster recent weeks in the stock market, most investors may have missed the plunge in another asset: bitcoin.

The cryptocurrency dropped 11 percent of its value in three recent trading days – part of a 66 percent fall in value since December, which is jaw-dropping even by its standards. Although the cryptocurrencies still show a blend of market strength as well as weakness, the shakeup is a sign of changing times.

Some of the latest losses may stem from stock market fears over a potential trade war with China. But analysts say the biggest factor behind the plunge in bitcoin and other cryptocurrencies is the prospect of government regulation. 

The irony is lost on no one. Cryptocurrency – the computer-software money that was supposed to replace cash – is instead beginning to get reined in by the governments it was built to bypass. Governments are doing it by denying that crypto or virtual currencies are currencies at all. Here's more on what's going on.

If virtual currencies aren't money, what are they?

In the United States, different federal agencies have different interpretations. According to the Commodity Futures Trading Commission, they’re a commodity, which is handy because the CFTC regulates commodities. The Securities and Exchange Commission (SEC) argues that they’re a security, which allows it to regulate the trading platforms that handle cryptocurrencies. The Internal Revenue Service (IRS) calls them property, like stock or real estate, which should be taxed.

The result? After losing in court, trading exchange Coinbase in February said it would turn over to the IRS data on some 13,000 customers who bought cryptocurrencies. 

Is the US the only country cracking down?

Hardly. China, which last year was the global center of the computer generation or “mining” of cryptocurrency, has clamped down so hard that everything cryptocurrency is under assault. India is also clamping down. South Korea, where much of the displaced Chinese crypto industry was expected to go, is toughening its rules on trading.

Why are countries acting now?

Several factors are at work. One is that the market value of virtual currencies has grown so large – more than $300 billion – that governments can no longer ignore them. Another factor is that criminals routinely use them to run scams, steal, and move money undetected.

Is criminal activity up because of cryptocurrencies?

Yes. Criminals are planting software on the computers of unwitting internet users so that their machines help carry out the calculation-intensive mining of cryptocurrencies. Also, scammers are floating new virtual money through initial currency offerings, presumably for a start-up even though the company is nonexistent, regulators allege. ICOs have prompted a crackdown from US states, whose “blue sky” laws can be even tougher than the federal government’s regulations.

In March, New Jersey stopped Bitcoiin, an investment entity, from offering an unregistered ICO, and North Carolina did the same to Power Mining Pool, which was trying to attract investors by claiming its computers were unlocking or mining seven cryptocurrencies. Regulators weren’t sure the computers or the managers even existed.

Are cryptocurrencies threatened?

The established ones – bitcoin, Ethereum, and Ripple – look like survivors. The technology on which they’re based, called blockchain, promises new money-saving innovations in finance and beyond. And the idea of an all-digital currency also has some popular appeal.

But the currencies are not immune to government action – or even the threat of it. When the SEC warned investors in March that they should deal with only registered online platforms to trade digital assets, the price of bitcoin fell 9 percent.

Will regulation tame the cryptos?

Some observers think the gold rush days of bitcoin are already over. Established companies and exchanges have moved in, allowing investors to buy derivatives of the currencies and hedge against price swings. After speculation drove up the price of bitcoin a meteoric 1,400 percent last year, the cryptocurrency lost nearly two-thirds of its value in January and February. The market has since trended down but at a less volatile pace. In the past month, values have swing between $6,600 and $9,600 – not stellar by its standards.

Still, many experts agree there’s a regulatory vacuum that needs to be addressed.

“Greater assurances are needed that the trades taking place are in fact legitimate and reflect buying and selling by independent actors,” Neil Gandal, lead author of a recent study on bitcoin price manipulation, writes in an email. “Unless and until such oversight is implemented, we cannot trust the exchange rate to reflect only legitimate sources of supply and demand.”

Will regulation kill cryptos?

It’s a fine line. Regulators want to make sure they protect investors from scams, while at the same time allowing the industry to develop and deploy the new technology in interesting ways. Overregulation could move the action elsewhere, which is what happened in China. 

It’s too early to tell who's doing the best job of setting the rules. Nations are taking various tacks.

Venezuela, whose paper currency has been reeling for years, has decided to create its own digital currency, the petro. Switzerland’s economics minister wants his country to become the “crypto nation,” and the Swiss have set up a working group to create a level playing field for the currencies. In the US, CFTC Commissioner Brian Quintenz has suggested that the industry create its own regulatory body, perhaps an international one.

If done well, regulation could help grow the market by giving investors confidence.

On Friday, reports emerged that hedge-fund trader George Soros, who called cryptocurrencies a bubble earlier this year, was now planning to trade them.

[Editor's note:  In the first paragraphs of this story references to recent market action were updated on April 17.]