Why Bitcoin lost 15 percent of its value in a few minutes

The value of bitcoins plunged more than 15 percent on Friday afternoon after the Securities and Exchange Commission rejected an application to create the first exchange-traded fund (ETF) for Bitcoin. The proposal would have made it easier for ordinary investors to buy bitcoins, but the SEC is worried that these investors could be cheated in the largely unregulated Bitcoin marketplace.

The ruling has been closely watched in the Bitcoin world. A favorable ruling would have given the cryptocurrency a stamp of approval from an influential regulator, and it also could have sparked a surge in Bitcoin’s price as it provided an easier way for people to invest in this exotic new asset class.

An ETF provides a way for people to buy an asset or a group of assets as if it were a single stock. There are ETFs that let people invest in gold, wheat, and every stock in the S&P 500. Right now, investing in Bitcoin is a cumbersome process that creates the risk of having your wealth stolen by hackers. A Bitcoin ETF could simplify the process, allowing anyone to invest in Bitcoin using an ordinary brokerage account.

The proposed Bitcoin ETF was the brainchild of Cameron and Tyler Winklevoss, twin brothers who once sued Mark Zuckerberg for allegedly stealing the idea behind Facebook from them when they were all students at Harvard. After settling that lawsuit for millions of dollars worth of Facebook stock, the brothers began investing in Bitcoin startups. They announced plans to create a Bitcoin ETF in 2013, and their proposal has been working its way through the SEC ever since.

But the SEC wasn’t impressed with the proposal. The law requires the SEC to make sure that a newly traded asset existed in a well-regulated market that adequately protects people from manipulation and fraud. But the SEC saw little evidence that these conditions were met. Bitcoin is primarily traded in unregulated markets located overseas, especially in China, and as a result, the price of bitcoins is extremely volatile. In the SEC’s view, Bitcoin exchanges are not yet mature enough to justify opening them to the general public.

“This creates a chicken-and-egg problem,” says Jerry Brito of the pro-Bitcoin Coin Center. “How do we develop well-capitalized and regulated markets in the US and Europe if financial innovators aren’t allowed to bring products to market that grow domestic demand for digital currencies like Bitcoin?”

The ruling hammered bitcoin’s value. In the minutes after it was published, the value of one bitcoin fell from $1,290 to less than $1,000. As I write this, it’s back up to $1,100, about 15 percent below its value before the ruling was announced:

Analysts expected that SEC approval for the Winklevoss proposal would send Bitcoin’s price soaring, as millions of ordinary investors suddenly had an easy way to buy into the Bitcoin market. That expected rise was likely priced into Bitcoin’s price ahead of the SEC ruling, which would explain why a negative ruling led to a plunging value for the cryptocurrency.

Even after the latest turmoil, however, Bitcoin’s value is way above its level in the past couple of years. A year ago, you could buy one Bitcoin for only about $400. Now it’s almost three times that value.