Why are cryptocurrencies dropping?

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If you're looking for answers as to why cryptocurrencies are crashing, these factors are all, to some degree, to blame.

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1. Crypto remains a minimal utility, speculative asset

Even though select cryptocurrencies have delivered life-altering gains, it's important to note that both the blockchain technology underlying digital currencies, and the tokens themselves, have very minimal real-world application.

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On one hand, a survey in January 2020 from HSB, a division of Munich Re, found that 36% of small and medium-sized businesses accepted cryptocurrency as a form of payment. Yet, data from Bitcoin, Ethereum, Dogecoin, Litecoin stats shows that only around 300,000 transactions are completed daily with Bitcoin (BTC -4.81%), the most popular digital currency. This compares to over 1 billion daily credit card transactions in 2018, and doesn't even account for global cash-based transactions. The role crypto/blockchain is currently playing in the payment and nonfinancial space is quite small.

The point is this: The technology underlying cryptocurrencies may be promising, but substantive real-world application is still a ways off. Investors have a habit of overestimating the adoption of new technology, and they appear to have done it again.

2. Select countries are cracking down on crypto

Investors should also recognize that not all governments are OK with the idea of cryptocurrency mining or use. Crypto mining is where people or businesses use high-powered computers to solve complex mathematical equations that validate groups of transactions (known as blocks) as true.

Last year, we witnessed the world's No. 2 economy, China, put its foot down on all aspects of digital currencies. It banned financial institutions from undertaking crypto transactions in May and wound up banning crypto mining a month later.

China isn't alone. More than a half-dozen countries worldwide have completely banned crypto, including Egypt, Iraq, Algeria, and Bangladesh. There are also more than three dozen countries where financial institutions are banned from dealing with crypto.

3. Cryptocurrencies haven't decoupled from the stock market

Another clear issue for cryptocurrencies is that they've been unable to decouple from the stock market.

With the U.S. money supply significantly increasing in the wake of the pandemic, crypto was viewed as a hedge against factors like inflation. Yet what we've witnessed is the stock market and digital currencies moving in unison. Last week, when equities endured their worst pullback since 2020, the crypto market tumbled in sympathy. It's quite possible the stock market could have more downside to come.

On the bright side, the stock market tends to rise far more often than it's falling. In theory, this bodes well for the crypto space. But the inability of these digital tokens to secure their own identity is concerning.

4. Margin debt is a worry

A fourth reason cryptocurrencies are crashing is margin debt. Margin is the amount of money borrowed with interest from a brokerage to purchase or short-sell securities.

Because the crypto space encounters differing levels of regulations by country, cryptocurrency brokerages also employ varying "rules" on their respective platforms with regard to margin. While some brokerages don't allow their members to use margin to purchase digital currencies, others allow users up to 100 times leverage on what they buy. Given how volatile this space is already, leverage of 50 to 100 times the cash value of an investment could wipe users out in the blink of an eye.

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