Digital Assets: Bitcoin Flash Crash – Post Mortem II

May 20, 2021 | Digital Assets, News

Elon Musk, Chinese regulators, and a nervous Wall Street were not the only culprits.

The generally assigned causes for yesterday’s market mayhem in bitcoin (and other cryptos) were Musk’s volte-face on bitcoin; the fresh warnings issued against cryptos by Chinese authorities; and a generally risk-off mentality on Wall Street. However, bitcoin’s kamikaze dive and then its spectacular recovery yesterday laid bare the fragility of the underlying systems, according to FT.

Systemic issue: Crypto exchanges falter

Unprecedented volatility and trading volumes yesterday led to technical issues at various crypto exchanges, including Coinbase (NASDAQ: COIN), Binance, and Kraken – the most prominent ones. According to CoinDesk, the exchanges suffered a range of issues:

  • Coinbase – “Intermittent downtime”
  • Kraken – “Connectivity issues”
  • Gemini – “Degraded performance”
  • Binance – “Network congestion”

It may be recalled that even in the equity market, commission-free broker Robinhood suffered outages during times of heightened volatility.

Systemic issue: Unbridled leveraging

According to some analysts, leveraged crypto positions held by retail and institutional players also played a self-reinforcing role in the flash crash.

As prices fell, leveraged bullish positions that fell short on margin (collateral) had perforce to be squared up by selling off amidst a market that was rapidly spiraling downwards – the forced sales only exacerbated the bearish downdraft.

“There were probably about $20bn of [bets that bitcoin will rise] liquidated yesterday, which was a large part of the price drop. It was an initial unrelated spark which grew because of the leverage,” said Sam Bankman-Fried, chief executive of FTX, the Hong Kong exchange to FT.

Is all lost?

Is bitcoin’s allure lost? Was there a bubble, and did it just burst?

According to Bespoke Investment Group, such massive drawdowns have been common in bitcoin’s history: The average drawdown from a record high is close to 50%, and on 69% of all trading days over the past decade, bitcoin has been down more than 40% from its record high. (MarketWatch)

So this might be just a correction, not the onset of a bear market.

Related Story: Bitcoin Collapses To $30K; Recovers To $40K In Wild Volatility

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