BTC’s Massive Weekend Flash Crash: Another Day in the Bull Cycle

KEY TAKEAWAYS 

  • BTC’s flash crash could be the result of either a whale trader short-selling or algorithmic trading exacerbated by high leverage;
  • Speculation builds around the combined effect of both: a whale trader sell-off coupled with algorithmic trading spiraling out of control, which eventually pushed out overcrowded leveraged long positions in the derivatives markets;
  • The market sentiment remains positive in spite of the crash. 

BTC broke the multi-year downward trend and hit a second historical peak of $12,100 on August 2, 2020 before plummeting 13% to $10,550 within one hour. Caught in the crossfire was ETH, which has outperformed BTC since earlier this year, off to a red-hot start in August, only to find its price plunging by more than 20%. 

The sudden price drop liquidated nearly $1.4 billion worth of leveraged positions across major exchanges. The largest single liquidation order was worth $10 million. 

There is plenty of speculation on what may have led to the flash crash. Some assume it was an Asian whale rapidly selling BTC whilst trading volume was thin. Others believe it could be down to algorithmic trading. Or it’s a combination of both – large sell orders triggered momentum-driven algo trading strategies that thrust the BTC price into a downward spiral. As a result, leveraged long positions were forced sold and brought the price further down. 

Market being moved by whale traders is not unheard of. Let’s recall the dramatic price hike on April 2, 2019. A mysterious whale purchased $100 million worth of BTC from Coinbase, Bitstamp, and Kraken, resulting in a 20% price increase in BTC. These three spot trading exchanges are the index price references to most derivatives trading platforms.

Source: Bybit

According to OTC professionals, large orders being executed on spot exchanges are highly unusual, and it is recommended that these orders should be fulfilled via OTC desks instead. The pattern underscores the possibility of market moving, as one could profit from leveraged positions in a price pump or dump.  

What triggered the sell-off this time? 

The aggregated open positions of BTC futures across major futures exchanges rose significantly before the crash, almost on par with the record high in February.

Source: Skew

The long-to-short ratio of BTC futures on several futures exchanges was around 1.5 to 2, and the Crypto Fear & Greed Index was 80 (extreme greed) before the crash. The bias was echoed in the options markets, as shown by the put-to-call ratio in the diagram below. Collectively, the data highlighted that market expectation skewed heavily to the bullish side. It is not surprising to witness a “sell the greed” attack. And it is not entirely groundless to speculate that the crash could be the result of a deliberate attempt to squeeze out overcrowded long positions with high leverage.

Source: Ecoinometrics

Although the crypto market is primarily retail-led, with more professional traders and institutional money entering, retail traders are increasingly vulnerable to risks of market manipulation and malicious pumping or dumping. 

For those who are new to derivatives or leveraged trading, it is advisable to use lower leverage and seek out products and services that can help mitigate losses caused by sudden market shifts. For example, traders who purchased long protection (mutual insurance), a risk management tool developed by Bybit, escaped the worst of the crash mostly unscathed, with the largest single compensation at 0.72 BTC.  

While the crash was painful, market sentiment remained untouched. According to Glassnode, a blockchain analytics firm, centralized exchanges witnessed a net outflow of 4,264 BTC on August 2, considerably higher than 436 BTC on the previous day. It means that traders didn’t rush to deposit BTC to cash out in spite of the incident. As the price of BTC has recovered, the bull run stands to carry on.