South Korea is one of the world's biggest cryptocurrency markets.
The crackdown on Seoul-based operators of some of the world’s busiest virtual currency exchanges comes as the government attempts to calm frenzied demand for cryptocurrency trading in Asia’s fourth-largest economy.
Justice Minister Park Sang-ki said in a press conference: "There are great concerns regarding virtual currencies and the justice ministry is basically preparing a bill to ban cryptocurrency trading through exchanges.”
The Government said in December it would apply more scrutiny to the exchanges, including attempts to stop anonymous trading.
Bithumb, the second largest virtual currency operator in South Korea, was also raided by the tax authorities on Wednesday.
An official at Bithumb said, requesting anonymity, said: “We were asked by the tax officials to disclose paperwork and things yesterday.”
The decision was interpreted as a signal for a sell-off in cybercurrencies and resulted in the crash in the market.
It comes after a crackdown on cryptocurrencies in China, after which market investors turned to South Korea and Japan.
The countries are a vital source of global demand for Bitcoin and other digital currencies.
Head of business development at cryptocurrency derivatives exchange BitMex, Greg Dwyer, said: Every crypto is priced at a 30 percent premium in South Korea.
A massive influx of money has caused an exaggeration in prices, which has concerned the South Korea Government.
By removing that, it looks like the market cap fell by 30 percent and so people rushed to sell because they’re not sure what’s happening."
Mr Dwyer said cryptocurrencies in South Korea trade at a premium because "it’s very difficult to get cash out of the country”.