News and market happenings can cause price movements. Today we did not see any major bearish news, yet we saw the entire market drop significantly over the span of a few minutes !
This is a very simple but unfortunate part of the crypto landscape of today. We are talking about leverage trading. Leverage allows traders to bet with more asset value than they currently own. It’s seemingly mind boggling whenever this concept is explained to those who don’t use it, yet somehow it still happens. We believe leverage trading was the cause of today’s massive drop in the market.
Leverage trading is a significant contributor to the volatility in the crypto industry. With volatility comes higher rates of return in exchange for gut wrenching swings in portfolio value. In order for crypto to truly thrive, leverage trading needs further regulation. When crypto investors are not buying the actual asset, but instead paper contracts ( derivatives), the purchases do not aide in driving the price upward. This creates a cascading effect that even one or two large accounts can significantly move the entire market. Once the cascade begins it is aggressive, one liquidation after another. Exchanges are forced to sell the Collateral, in this example your 1 Ethereum, but magnified by each person who was liquidated. Add in a few panic sellers and you get a massive market dump.
What is Leverage?
The concept of leverage is important to understand. For example, if you leverage your 1 Ethereum say at 3500$ value, and you wanted to make the trade of a lifetime using leverage you could open a 20x leverage trade. Using this massively risky strategy traders can effectively place a bet with 20x the buying power. So, even though you only have 1 Ethereum, you could conceivably trade as if you had 20 Ethereum. This 3500$ Ethereum bet is now 70,000$ of potential trading power. The issue with this strategy is twofold. Yes you can make a killing if market volatility works in your favor, but – if the market were to move down just 5%, your account value is down 5% of the $70,000 bet you made, or your entire account value. When your account (factoring in leverage) moves below the value of the actual asset you own, the exchange or asset holder can sell your asset (collateral) to recoup losses.
This 5% works in both directions, 5% up, you are up 100% sitting pretty, 5% down and you are liquidated. The exchange allowing the leverage would give a margin call as you approach an agreed upon threshold, say 20% loss in value of your initial collateral. Today, leverage traders did not have time to react. If your crypto backup collateral was not already on the exchange using leverage, you were out 100% of your bet.
Normally if you wanted to stay in your bet, at this 20% loss of value level you would need to add more collateral or the exchange holds the right to sell your position at a loss. Since the crash happened so quickly (likely initiated by one or a few large sellers), even people with 3x leverage were liquidated. When prices move radically in either direction, we also start to see things like stop losses (automatic settings on accounts that initiate an asset sale if the price drops below a certain value), etc. occurring. Normal market tendencies or large account transactions started the snowball. We saw a lot of assets get liquidated which caused some panic and stop loss triggering.
We watched the price of Bitcoin, a near trillion dollar asset drop from $48k+ to <$44k in the span of minutes. As such, the exchanges and asset holders had to quickly cover losses. Many investors were trying to buy during this dip and Coinbase and other exchanges struggled to keep up with the demand and volume.
When we saw the prices of assets we are invested in drop so quickly, we began mashing the buy button on MATIC, DOT, OGN, ADA and others. Most of those orders were cancelled or not processed by the exchange (since the price was moving faster than they could keep track of), but we did have a couple hit that were great value plays. We don’t like that.
Crypto is not a get rich quick scheme, but a get rich, substantially faster than the stock market play. Stay safe out there, and remember to do your own research. None of us have good enough luck to leverage trade. Stay away from it!