- Bitcoin fell as much as 17% on El Salvador’s first day of making the cryptocurrency legal tender.
- The sudden drop triggered over $3 billion in liquidations in 24 hours and spilled over to altcoins.
- We asked four crypto experts about what was behind the crash and altcoins worth buying on the dip.
Bitcoin picked just the day to show its extraordinary volatility.
As the cryptocurrency was officially adopted as a national currency in El Salvador on Tuesday, it tumbled as low as $43,000 after breaking above $52,000 for the first time in three months.
While some traders saw the sudden crash as a “buy the rumor, sell the news” event, others say there are bigger forces at play. Most evidently, the cascading liquidations of leveraged futures are partly to blame.
The price slump “appears to be mostly coming from highly leveraged traders trend following,” as too many people anticipated new highs, Lucas Outumuro, the head of research at the blockchain-analytics firm IntoTheBlock, told Insider in an email.
He added that the ratio of perpetual swaps open interest to bitcoin’s market cap had recently reached above 1.55%, an indicator for near-term price corrections.
When traders take out a leveraged futures position in the hope of amplifying returns, they must post collateral in their margin account or risk being liquidated. The higher the leverage used, the higher the collateral amount they must deposit. As a result, sudden price moves could cause traders to quickly fall below margin requirements and get liquidated.
As of Wednesday morning, more than $3.25 billion in crypto positions had been liquidated over 24 hours, affecting more than 300,000 traders, according to Bybit, the crypto exchange where traders can still use hundredfold leverage.
Liquidity evaporates amid a perfect storm
While liquidation cascades moved prices, a mix of factors caused a
shortage that intensified the dramatic intraday moves, according to Patrick Heusser, the head of trading at Crypto Finance Brokerage.
“On Tuesday, we had the perfect storm because you had the long US holiday weekend. You had an upward moving market, so the market makers were notoriously short cash because they had to hedge all their futures they lost to the leverage guys,” Heusser told Insider, adding that these were his personal thoughts. “And then they were probably a bit too complacent on Monday, not sending enough capital quickly to their trading venues.”
Against such a backdrop, when the market started to tumble, market makers ran out of dollars and stablecoins to buy tokens at some point. “If the market continues lower, you pull out, so the market makers were turning off their machines. They pulled out,” he added.
As market makers and liquidity providers ran out of capital to quote, crypto exchanges also encountered various operational issues that caused them to temporarily go offline, as is typical in such sudden crashes.
A breather for altcoin season and NFT frenzy
The latest crypto crash came amid a trading frenzy over altcoins and nonfungible tokens, but traders and analysts said that it did not spell doom for the two red-hot trends in the $2 trillion market.
“We typically see the altcoins making all-time highs while BTC and ETH take a breather towards the end of the cycle. I’d say this is more of a local top than a cycle top,” Kevin Kang, a founding principal of crypto asset hedge fund BKCoin Capital, told Insider in an email. “I’d expect the market to digest the rapid movement in the coming days trading sideways, and some of the quality altcoins will continue to rally towards the year-end.”
But as crypto prices remain in retreat, there could be less risk seeking in the short term.
“In some of the NFT markets, the floor hasn’t really moved much. It’s just the overall dollar value has dropped 20% to 30% because coins linked to the NFTs drop that much,” Heusser said. “In a market like yesterday, no one is in the mood to buy. It doesn’t really trade, so the floor doesn’t really change.”
Altcoins worth buying on the dip
After this week’s leverage washout, some analysts are predicting more volatility ahead.
Joseph Edwards, the head of research for Enigma Securities, has been very negative on crypto-market prospects for September for a while.
“The key thing for investors to understand is that there’s no medium term here,” Edwards told Insider in an email. “If you’re looking to invest based on potential adoption and partnerships in the next six to 12 months, you’re likely to see underperformance both in that term and after.”
He believes that right now is all about getting exposure to assets that could become an integral part of crypto in five years, he said, which means going heavy into bitcoin (BTC) and ethereum (ETH) for the most part.
While predominantly long bitcoin, Heusser is also bullish on the Solana ecosystem.
“Drops like what we saw yesterday, where I feel confident that it was one of these washout drops, picking up some altcoins has even more value than trying to buy the dip for bitcoin,” he said.
IntoTheBlock’s Outumuro said he believed that it was probably better for investors to have higher bitcoin allocations until the volatility settles.
“The only few altcoins that may continue to do well near term are smart-contract platforms with current incentive programs such as avalanche (AVAX), fantom, and celo (CELO) given that they are seeing increased usage and total value unlocked and may follow solana’s path,” he said.
BKCoin Capital’s Kang added: “I think in terms of altcoins, smart-contract platforms such as solana, terra (LUNA), and cardano (ADA), as well as Web 3 tokens and NFTs such as arweave (AR), axie infinity (AXS) have outperformed bitcoin and ethereum significantly this year and will continue to do so in the near future.”