The crash came against the backdrop of a world waking up to realize that COVID-19 was more than ‘just a flu.’ The S&P 500 plunged 9.5% in the biggest single-day drop since 1987 while gold dropped 3.5%, even though it usually serves as a safe haven. Meanwhile, oil had its worst week since 2008, losing a quarter of its value as Russia and Saudi Arabia continued waging a price war by pumping more oil into a slow economy.
Yet none of this compares to the dramatic crash that took place in the crypto markets. Bitcoin fell more than 50% in the biggest single-day drop since 2013, with altcoins experiencing even more damage.
At a high level, explaining the market movement is straightforward: an impending global economic meltdown caused panicked traders to sell off speculative bets on crypto. That narrative is likely true, but markets are chaotic, opaque systems with many intertwined, moving parts. Crypto markets are even more so. BTC rebounded in the following weeks surging more than 90% from its $3,800 low, so what caused this short term panic? Beneath the surface, there were a number of ingredients that, when thrown together, caused the crypto market to tank especially hard on March 12.
1. Leveraged investors cause a cascading sell-off
In any volatile market event, loans will be called and positions will be liquidated. While leverage exists in nearly every market, the scale and scope of leverage in crypto has been growing significantly over the past several months through the expansion of the derivatives markets and USD lending platforms such as Blockfi and Celcius. Whereas margin is regulated and limited in equity markets, in crypto many offshore exchanges allow investors to leverage their positions up to 100x. In such cases, a move of 1% in the opposite direction could cause the borrower to lose their entire collateral.
On March 12, an initial price drop led to initial liquidations, forcing levered investors to sell off their collateral. This pushed prices down even further, which led to more liquidations and more losses. Lending desks were issuing margin calls faster than their borrowers could answer them, triggering a wave of collateral liquidation. This added a tremendous amount of fuel to the fire. Liquidity being much higher on derivatives platforms sent perpetual swaps funding collapsing towards -1%/day (you were getting paid to borrow) and the futures curve in steep backwardation (huge demand for spot BTC). At one point, the March futures on Bitmex was trading at a staggering 10% under the current spot price.
2. Bitcoin network congestion and skyrocketing Ethereum gas fees
The limitations of base-layer protocols on full display on March 12. As volatility spiked across the market, traders struggled to get their crypto between exchanges to keep their positions afloat or to close out arbitrages. Competition for block space on Bitcoin, which mines a new block only once every ten minutes, made it difficult for traders to shuttle funds between the different trading venues and react to the price changes in time. Meanwhile, on Ethereum, network congestion caused the price of gas to skyrocket. In one such example, oracles used to feed prices into DeFi dApps had to pay up to $28 just to update their price feed. Without up-to-date prices, DeFi dApps on Ethereum simply froze, creating exploitable opportunities including 36% of MarkerDao auctions failing to clear properly with zero bids.
3. Bitmex, Deribit and crypto “circuit breakers”
It wasn’t just decentralized networks feeling the strain. Traditional markets tend to have controls in place called circuit breakers, which pause trading when markets become extremely volatile. NYSE and Nasdaq both recently triggered their circuit breakers several times to pause trading after 7% downward moves in the market. Crypto markets don’t have circuit breakers, but that doesn’t mean that markets don’t short circuit.
Two of the most liquid platforms in crypto, BitMEX, and Deribit, were each down intermittently for a few hours, leaving their traders unable to fund their account with much-needed margin and exposing them to heightened liquidation risks. BitMEX went offline “for maintenance” for an hour right in the heat of the price collapse. As Bitmex came back online, BTC price had rebounded, leading some people to speculate that the action was an intentional circuit breaker in order to save several hundred million dollars in liquidations that would have been otherwise required during the downtime. Whether intentional or not, the market started to rebound shortly after BitMEX went down.
After A Brisk Recovery, What’s Next For Bitcoin?
Bitcoin has posted a swift recovery since then, rebounding strongly back into the familiar 6,600 region it occupied for a large part of 2018. While traditional markets are responding to their distress by printing more fiat currency with which to stimulate the economy, Bitcoin’s code takes a completely opposite approach.
In just one month, Bitcoin’s annual inflation rate will drop to just 1.3%, below the Fed’s annual inflation goal of 2%, following the highly-anticipated Bitcoin halvening. The halvening happens once every four years and is a prime example of Bitcoin’s ‘hard’ monetary policy and its predictable, fixed supply schedule. Additionally, miners that cannot keep up with the rewards reduction will be forced to shut off their machines, bringing increased efficiency to the network.
‘Black Thursday’ took crypto down, but not out. Following a brisk recovery, Bitcoin is back in a comfortable region with sentiment beginning to turn as we head towards the halvening.
No matter the outcome, volatility — and opportunity — are likely here to stay.
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