The open-source Bitcoin (BTC) cryptocurrency is a virtual currency that has gained significantly in popularity and in value over the course of 2013—that is, until today.
Bitcoin's value had been hovering above $1,000 USD per BTC for most of December, but a decision made in China has triggered a collapse in value that is unprecedented in the short history of Bitcoin's existence.
Bitcoin lost half its value overnight—with BTC to $USD rates hovering around $500 on major BTC exchanges, including Mt. Gox, on Wednesday morning.
The collapse in Bitcoin's value is not a security-related incident, as there has been no major vulnerability found in Bitcoin and no big breach that triggered the decline. The dramatic decline in BTC value is due to just a single factor in a single country that is having worldwide repercussions. The government of China has officially banned payment companies from providing financial clearing services for BTC and other virtual currencies. BTC China, which bills itself as the largest Bitcoin trading platform in China, announced Tuesday night that it was no longer allowed to accept Chinese currency to trade for BTC.
The move shouldn't have been a major surprise as the Chinese government had warned on Dec. 5 that Chinese financial institutions should not accept virtual currencies.
The corresponding 50 percent decline in the value of BTC late Tuesday night and early Wednesday morning is in some respects a knee-jerk reaction to the Chinese move, but it is one based on the same economics of any other commodity that is traded. With the Chinese financial restriction on using Chinese currency to trade for BTC, there is a liquidity risk.
Financial markets require liquidity to maintain healthy volumes, enabling traders to move in and out of equity positions. The most successful financial markets in the world have long been the most liquid, and lack of liquidity has always triggered market corrections.
The promise of Bitcoin is that it is an unregulated, distributed and decentralized form of currency that is not subject to the whims of public policy or big governments. As it turns out though, a big government (China) can influence Bitcoin with its policies.
As opposed to a traditional currency, where a central bank or government authority can adjust interest rates or currency availability through quantitative easing or even just simply printing more money, there is no such action available for Bitcoin. That means there is no one large government and no International Monetary Fund (IMF) to bail out Bitcoin.
There are, however, lots of big investors in Bitcoin today, and some of the same mechanics used for a traditional equity can also be used. The big money movers can attempt to buy up Bitcoin (now at a substantial discount) in a bid to drive up the price. Great traders have always found a way to profit from market declines, following the adage of buying low and selling high.
Whether or not Btitcoin's decline to $500 USD is a correction or a longer-term trend remains to be seen. It is, without a doubt, a test of the resiliency of virtual currency, and time will tell whether Bitcoin will emerge unscathed.
Sean Michael Kerner is a senior editor at eWEEK and InternetNews.com. Follow him on Twitter @TechJournalist.