Cryptopocalypse or Just Another Day in the Volatile Life of Bitcoin?

Fear, uncertainty and doubt are rampant in the cryptocurrency community the morning after Bitcoin and many other cryptocurrencies experienced a rapid and significant drop in price overnight. Rapid declines in price can be unnerving but before taking any rash actions such as liquidating your HODL portfolio or halting any trading activity its important to take a step back and assess what transpired.

Let’s look at a few specific questions: (1) What happened?; (2) What caused Bitcoin’s price to drop initially?; (3) What caused Bitcoin’s price to drop so rapidly?; and (4) Is this an unprecedented event or have we seen this before.

What Happened?

While Bitcoin had been showing weakness most of April 17 declining from $62,400 to $60,700 from midnight until 7pm ET, the downward velocity of Bitcoin’s price action started accelerating with Bitcoin dropping another $2,000 over the next four hours. At 11pm ET, Bitcoin’s price began a precipitous fall. From 11:10pm to 11:20pm, Bitcoin dropped almost $1,000. Over the next twenty minutes, Bitcoin experienced some stomach-churning swoons. From 11:20pm to 11:30pm, Bitcoin dropped from $57,700 to $55,000 before rebounding to $56,600. Then from 11:30pm to 11:40pm, Bitcoin plummeted $5,300 to $51,300 before retracing to $54,700. Since 11:40pm ET Saturday evening, Bitcoin has meandered between $53,000 and $56,000 and it attempts to reclaim some relative price stability.

What Caused Bitcoin’s Price to Drop?

An understanding of market mechanics is important when analyzing what caused Bitcoin’s price to drop. As with any asset with an actively traded market, Bitcoin’s price can begin to be impacted by a catalyst but then market mechanics can magnify that impact far beyond what might be intuitively expected. As described above, Bitcoin was already exhibiting some weakness throughout the day. Several items of information became known that might have contributed to Bitcoin’s pricing weakness. Preceding Bitcoin’s accelerated price drop was a tweet from FXHedge at 10:42pm ET:

While other catalysts have been offered up by various commentators (e.g., power blackouts in China impacting Bitcoin miners there, Coinbase insider conspiracies, etc.), these seem somewhat dubious. However, the FXHedge tweet appears to coincide with the beginning of Bitcoin’s price decline. However, the tweet itself, which amounts to rumors and not confirmed news, does not explain the magnitude and velocity of Bitcoin’s price deterioration.

What Caused Bitcoin’s Price to Drop So Rapidly?

As with any asset traded across numerous markets, Bitcoin’s price action is prone to market mechanics that may magnify the impact of a catalyst in a way that exceeds what you might intuitively expect. In the case of Bitcoin’s price on the evening of April 17, we see this phenomenon occurring. The futures market for Bitcoin has increased dramatically over the past few months.

As you can see in this chart, the notional value of Bitcoin futures contracts has increased from $2 billion to over $25 billion in the past year. These futures contracts represent leveraged bets on the price action of Bitcoin involving 10x or 25x leverage, meaning the trader might risk $1,000 but make a $25,000 bet on the price of Bitcoin using leverage. Futures trading can be extremely lucrative but is also very risky. Trading with 25x leverage, a four percent decline in the price of Bitcoin results in what is called a “liquidation” whereby the exchange forcibly liquidates the trader’s position with the trader losing its entire investment.

What we saw the night of April 17 over the course of 10–20 minutes was a liquidation snowball. Bitcoin’s falling price resulted in futures contracts being liquidated. Those liquidations resulted in Bitcoin’s price dropping further leading to more liquidations. This vicious cycle continued until a significant chunk of the futures positions were liquidated. As you can see in the chart below, almost $4 billion of futures contracts were liquidated in a matter of minutes:

Is This Dip Unprecedented Or Have We Seen This Before?

One of the knocks against Bitcoin is the volatility of its price. So it should come as no surprise that we have seen dips like the April 17 dip before. While the velocity of the dip was alarming even for Bitcoin, the magnitude of the dip is not unprecedented. We have seen in the past few months drops similar to the 13 percent drop in Bitcoin ($62,400 to $54,700) we saw on April 17.

From January 9 to January 12, we saw a 16 percent drop from $40,600 to $33,800. From February 22 to February 23, Bitcoin experienced a 15 percent drop from $57,500 to $48,800. Also, during the January and February drops we saw similar spikes in futures liquidations. Though the April 17 futures liquidations were much larger due to the rapid growth of Bitcoin futures trading.

Notably, Bitcoin appears to be behaving normally (for Bitcoin) during its recent bullish cycle. For the chartists out there, Bitcoin remains above the daily 55 exponential moving average (EMA) even after this recent swoon. The daily 55 EMA has functioned as a strong support level for Bitcoin since last fall.

Thus, while Bitcoin’s price action was certainly harrowing and many that might be relatively new to Bitcoin may be understandably anxious about what the near term future holds, this sort of volatility is just part of the Bitcoin experience. And what we saw the evening of April 17 is not out of the ordinary for Bitcoin.

Cryptocurrency Enthusiast