Bitcoin (BTC) fell 7.5% on the morning of December 11th, marking the steepest intraday decline since mid-August. Bitcoin is still up over 150% since the beginning of the year, but a large, sudden and unexpected “red candlestick” on the chart has renewed the volatility of Bitcoin, the largest cryptocurrency by market capitalization. Make me feel the pain.

Last week, it seemed like there was little in Bitcoin’s way, and many of its long-standing problems seemed to be resolved. Why did Bitcoin fall?

First, the reason for the price increase

It would be better to consider why prices were rising in the first place.

For example, Binance, the largest and most controversial cryptocurrency exchange, has agreed to pay a $4.3 billion fine to U.S. authorities in order to continue operating. did. Despite the “historically” high fines, it seems possible to survive.

The settlement also sheds light on the resolution of the US Securities and Exchange Commission’s (SEC) legal battle between US-based exchanges Coinbase and Kraken.

Overall, the regulatory situation in the United States appears to be improving. Although the regulations have not yet been “clarified,” proposals have been made by influential lawmakers, and future developments are expected.

In addition, there are various issues such as the Bitcoin halving (reducing the amount of newly circulating Bitcoin by half) scheduled for 2024, and the possibility that the SEC will approve a Bitcoin ETF (exchange traded fund). Some events are predictable. Market observers have been talking about these two events, and ETFs have been the main driver of Bitcoin prices lately.

Next is the macroeconomic forecast. Bitcoin, sometimes referred to as “digital gold” because it theoretically functions as a store of value similar to gold, is rising alongside physical gold. Gold futures recently hit record highs, partly due to inflation concerns.

Interest rates controlled by the Federal Reserve are at their highest levels in the 21st century due to efforts to curb inflation and cool an overheated economy. Many experts think the Fed’s efforts are over soon, with some saying it could cut interest rates in the first half of next year.

Lower interest rates are good for Bitcoin, just as they are good for economic activity. Lower interest rates “make money cheaper” by making it cheaper to borrow, which means more money is available. And when interest rates fall, the expected return on investment falls, making safe investments like government bonds less attractive and pushing capital down the risk curve into asset classes like crypto assets.

Possible causes of the sharp decline

I’m not sure how to explain the “flash crash” on the 11th that started with the market correction on the night of the 10th. Crypto-related stocks such as Marathon Digital and Riot Platforms fell by double digits on the 11th, even as the tech-heavy Nasdaq continued to rise. .

Many, like Greta Yuan, head of research at digital asset solutions company VDX, focused on the macro picture. On the 8th, better-than-expected employment data was released, and Wall Street Journal reporter Nick Timiraos predicted the Fed would cut interest rates in 2024. This “fine adjustment” can be explained by “better-than-expected non-farm payrolls and a decline in the unemployment rate,” Yuan said.

Meanwhile, Lucy Hu, senior analyst at digital asset management firm Metalpha, said this could be part of a “rational process of profit taking.” In other words, traders made enough profits to cash out.

CoinDesk’s Omkar Godbole said funding rates for crypto derivatives are “overheating.” The amount of leverage in the crypto derivatives market may not explain what caused the market correction, but it certainly helps explain why it could fall so quickly and so significantly.

Godbole also used expressions such as “excessive bullish leverage” and “overcrowding of long positions.”

Double-edged sword

When traders are overleveraged, they are effectively trading borrowed money. This means you are helping to drive up asset prices with capital that doesn’t actually exist, and when prices fall, they get wiped out (or liquidated), with a far greater impact on the broader market. . Leverage is great until it’s not.

Falling prices also mean, for better or worse, that leverage has been reset to a more healthy amount. And I want readers to take away the lesson that in crypto assets, small changes can cause big swings in prices, especially when everything seems to be moving in your favor. Stay sane and realize that volatility is a double-edged sword.

｜Translation and editing: Akiko Yamaguchi, Takayuki Masuda
｜Image: Shutterstock
｜Original text: Explaining Bitcoin’s ‘Flash Crash’