Ethereum, along with all other cryptos, experienced a huge sell-off in the last week. Just this month Ethereum reached over $4,300. Since then it dropped as low as $1,950 a now rests at around $2,500.
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The drop from its all-time high represents a 42% decrease. But why such a harsh drop? What happened to make the cryptocurrency plummet from the top, and can it climb back to a new all-time high?
Correlation With Bitcoin
Ethereum, as with most cryptocurrencies, is highly correlated to Bitcoin’s movements. While Bitcoin and Ethereum are vastly different in their design and use cases, the majority of people still lump all cryptocurrencies together as the same thing. With Bitcoin being the most popular, a drop in Bitcoin can lead to drops in the rest.
This will likely change as people slowly gain more exposure to cryptocurrencies and how they work, but right now they are all correlated in their price movements.
Due to this view that cryptocurrencies are all largely the same, when Bitcoin drops so does everything else, and Bitcoin dropped hard this week.
So, if Ethereum follows Bitcoin’s fluctuation, then why did Bitcoin drop?
Tax Day
Tax day was on the 17th. Historically, tax day is correlated with down markets as people sell off their investments to pay due taxes.
Tax day affects crypto and traditional markets too. On the 17th, the S&P 500 also had a rough day.
https://www.tradingview.com/symbols/AMEX-SPY/
Elon Musk and Tesla
Though many crypto enthusiasts would not admit that one company and its billionaire figurehead has the power to affect Bitcoin’s price, Bitcoin tumbled sharply right after Tesla announced that it would stop accepting the crypto for its cars.
After the announcement, Musk engaged in various arguments on Twitter regarding Bitcoin’s energy efficiency, leading many to fear that Tesla could take it one step further and sell its Bitcoin holdings worth well over $1.6 billion.
While concerns over Bitcoin’s energy use grew, Musk reassured Twitter that Tesla had “diamond hands” and would not be selling.
Tesla has 💎 🙌
— Elon Musk (@elonmusk) May 19, 2021
Even though there was a strong sell-off, those leaving the market seemed to be newer investors panic selling as addresses that are accumulating Bitcoin have continued to grow through the drop.
https://studio.glassnode.com/metrics?a=BTC&category=Addresses&m=addresses.AccumulationCount&s=1609060662&u=1621555200&zoom=
Fears of Regulation
Perhaps one of the largest drivers of fear in the market was fresh concerns over regulations. Both the U.S. and China made announcements about coming regulations for taxes and other things.
In the U.S., the Treasury Department announced that it would begin to require any transfer of $10,000 or more to be reported to the IRS, though it is unclear how such a law would actually be enforced in the real world.
A report released by the Treasury Department said that cryptocurrencies were a growing concern.
“Still another significant concern is virtual currencies, which have grown to $2 trillion in market capital-ization. Cryptocurrency already poses a significant detection problem by facilitating illegal activity broadly including tax evasion.”
China also called for tighter regulations around mining and trading behavior. A statement from China said that it is time to “crack down on Bitcoin mining and trading behavior, and resolutely prevent transmission of individual risks to the social field.”
The country’s statement continued, saying “It is necessary to maintain the smooth operation of the stock, debt, and foreign exchange markets, severely crack down on illegal securities activities, and severely punish illegal financial activities.”
Where Does Ethereum Go From Here?
While the whole cryptocurrency market has followed Bitcoin in its steep decline, Ethereum has a lot of upcoming updates that could help to lift the crypto out of the hole.
In the next year or so Ethereum will experience massive changes to its system known as Ethereum 2.0. These changes will increase transaction speeds and greatly reduce the cost to move money on the network. In this update, Ethereum will move to a proof-of-stake consensus system instead of proof-of-work.
Right now, transactions on the Ethereum network can cost $100 or more, making transactions of anything under that amount impossible and not worth it. After Ethereum’s update, this issue will go away, greatly reducing the barrier to entry and allowing anyone to move money for far smaller fees.
Why does this matter for Ethereum’s price? It matters because with lower fees the network is suddenly opened up to more people that could not previously afford to use it. This increased use can help to bolster the decentralized financial ecosystem on Ethereum and in turn its price.
Other than moving to proof-of-stake, Ethereum has another update that will change the way transaction fees work and help to lower inflation, thus making it more scarce. The update, called EIP-1559 (Ethereum Improvement Proposal), will lower the volatility of transaction fees by burning a portion of the fees, rather than giving it all to miners.
Though this will cause miners to make less money, it will allow more people to use the network for smaller transactions. This update will replace the auction-style system that exists today for a standard rate known as the base fee. Instead of miners setting the fees the network does, and instead of the fees all going to miners most of them are burned, helping to lower Ethereum’s inflation rate.
The combination of lower fees and a lower barrier to entry for more individuals, along with a new system to lower the inflation of Ethereum, are both good signs for the crypto’s price. Should these new updates prove effective, Ethereum’s ecosystem and its price stand a good chance to grow.