The sentiment in the crypto market had been extremely bullish for quite some time with the entire market seeing a clear uptrend since March of 2020. This year alone, Bitcoin saw a price increase of 125% to the top of about $65k. Since March 2020, the run had been over 1600%. Corrections in such strong trends are common. However, the drop experienced this week was far from common and resulted in a drawback of over 50% from Bitcoin’s all time high and 30% on the 19th of May.
We will discuss what caused this drop to be so rapid and severe and how we might move on from this massive selloff.
To start off, there had been some news releases that resulted in some FUD (Fear, Uncertainty, and Doubt) in the markets leading up to the 19th of May.
China “crypto ban”
One major source of FUD was the news release of a China “crypto ban.” China has talked about banning cryptocurrencies for a number of times throughout the years. It banned domestic cryptocurrency exchanges in 2017 and issued a statement in 2019 that it would block access to all domestic and foreign cryptocurrency exchanges as well as ICO websites.
However, the supposed crypto ban of this week was not a full on crypto ban as residents of China will still be able to hold cryptocurrencies. They are just warned about cryptocurrencies being speculative assets and “are not supported by real value.” Instead, three associations under the Central Bank of China issued a document wherein they called for a ban on financial institutions and online payments channels providing any cryptocurrency-related service, including trading-related services. For China, this is nothing out of the ordinary as this has been the trend for years.
Tesla stops accepting Bitcoin
A lot of the retail investors seem to cling onto the words of Tesla CEO Elon Musk. Markets have shown strong reactions to his opinions about Dogecoin as well as Bitcoin. The news that Tesla had purchased Bitcoin and would accept Bitcoin payments was welcomed by the market. So when he announced that Tesla would no longer accept Bitcoin due to the massive amount of energy required to uphold the network which partly comes from fossil fuels, some saw this as a big negative event for the market. However, the energy consumption by Bitcoin miners is far from news and has been debated for years. So the idea that this should lead to a sudden sell-off simply because one company or person repeats it seems odd.
This week also marked the week that Tether (USDT) was to release its first report concerning the reserves backing the stablecoin. It was forced to do so after reaching a settlement with NYAG earlier this year that resulted from a lawsuit concerning whether USDT was truly fully backed.
Tether showed that it has the assets to fully back Tether. However, people were concerned whether there would be enough liquidity in case more than 3.87% of USDT would have to be cashed out in a short time span. It is unclear what exact investments the company holds on its balance sheet and whether they are risky or not. So this report is disappointing to the community who were hoping to get more clarity about the backing of USDT.
Although these news messages may have influenced the sentiment among some retail market participants after which Bitcoin did see a price drop, this was not the real reason for such a massive sell-off as neither China or Tesla fundamentally changed anything about the market despite many people’s arguments. Everybody has been anticipating China’s negative stance towards crypto as this has been negative for years. And Elon Musk’s argument against Bitcoin is not a new insight either. It is worth noting that Tesla has not even sold the Bitcoin that they currently hold on their balance sheet.
While the report of Tether is disappointing and lacks transparency to the public, it should not lead to such a devaluation of Bitcoin by itself. However, these news messages could have helped the start of a correction in a market that had already been performing well for quite some time.
The entire crypto market saw a massive crash on the 19th of May due to a combination of circumstances that resulted in panic in the market with the different news releases giving an initial push.
One of the reasons is that a lot of this rally was driven by trading derivative products such as futures. This is highlighted by the data provided by derivatives exchange FTX.
Due to the recent euphoria in the market, many new traders have entered. Besides buying different cryptocurrencies at high price levels directly, a lot of them also experiment a lot with futures as they look for a get rich quick scheme. That traders were massively longing Bitcoin through futures can also be seen by looking at the funding rate for Bitcoin perpetual futures across exchanges. This was positive for a long time, implying that traders were willing to buy futures at a premium to the spot price of Bitcoin. In return, they had to pay a funding rate to the shorts.
Once prices started to drop, traders were forced to sell their long positions or risked liquidation. But as this happened, the price kept moving lower, forcing a lot of liquidations in the derivatives market. This turned into a domino effect of exchanges forcing liquidations of long positions in the futures market and people panic selling in the spot market. Once this happens, things go fast, as we saw on the 19th of May. Over $8 bln in future positions were liquidated.
To make things worse, a number of the major exchanges faced technical issues during this period which resulted in even more panic.
- Kraken listed “connectivity issues” on both its web and mobile. It also experienced an issue with the “Instant Buy” feature.
- Coinbase’s status page indicated that there was “intermittent downtime.” Issues spanned its website, mobile, and APIs. ERC20 withdrawals were delayed due to congestion of the Ethereum network.
- Binance temporarily suspended trading and redemption for most of its leveraged tokens. Furthermore, it paused ERC20 token withdrawals due to network congestion.
- Gemini reported “degraded performance” as well as listing API problems.
- Bitfinex’ stable coin, Tether (USDT), briefly lost its supposedly stable value as it dropped to $0.84 per token instead of the $1 goal.
The chaos in the markets also led to chaos on the Ethereum blockchain with gas prices briefly skyrocketing. Because DeFi participants use different combinations of products across lending platforms, decentralized exchanges, etc. and increasingly use second layer solutions, the brief surge in gas price made it difficult for them to get tokens back to the first layer and close their positions when prices started dropping. This ultimately led to even more liquidations and resulted in the largest single day DeFi liquidations by far.
A total of $573 mln was liquidated on the 19th of May during the time of the drop.
So, the combination of all these events led to a massive acceleration of the drop and ultimately brought Bitcoin down over 30% on the day with multiple altcoins suffering even worse declines. The big question then of course is what different market participants did during the drop.
Long term vs short term holders
A lot of the major players in the Bitcoin market do not use regular exchanges to buy and sell their Bitcoin since they would influence prices too much. Instead, they use Over The Counter (OTC) tradin. During the large dips of the last year, the number of transfers from OTC desk wallets surged, implying that whales use these events of panic to purchase more Bitcoin.
We can see that the same thing happened during the sell-off of the 19th of May. The number of transfers from OTC desk wallets even reached a new all time high.
A day before the final sell-off, Glassnode released its weekly on-chain analysis report. Here, we can clearly see how short term and long term holders of Bitcoin behave during times of rising and declining prices.
Long-term holders use rising prices to offload some of their holdings and declining prices to accumulate. Short term holders tend to just follow the price due to FOMO when everything rises and panic sell when it declines. We could already see the same trend starting before the dip on the 19th of May. It is likely that this trend has sustained with long term holders accumulating more Bitcoin during the dip as the OTC desk wallet outflows suggests.
Possible bottom signal
The Spent Output Profit Ratio (SOPR) is calculated by dividing the price sold by the price paid for a position. An SOPR value above 1 implies that the coins moved on that day are selling at a profit on average. The opposite is true in case of the SOPR being less than 1. The short term SOPR only takes into account positions of the past 155 days.
The chart clearly shows that short term Bitcoin holders were selling at a loss, bringing the SOPR ratio down to levels only seen during the previous major crashes that led to a price surge. While far from being a guarantee that the bottom is in, it is a good signal.
More China FUD
After the market dumped on the 19th of May, China announced that it aimed to ban crypto mining in the country. This is currently seen by many as bad news for the crypto market whereas before it was bad for the market that Chinese miners were a major portion of the hashing rate, spurring centralization concerns for Bitcoin. The fact that a lot of Chinese Bitcoin miners use highly pollutive fossil fuels to power their mining was also a hot topic. Should China indeed ban mining, these issues could be of the past. Furthermore, this is not the first time that China has mentioned the banning of mining Bitcoin. The last time was in 2019, also during a lot of panic in the markets.
So a lot has happened during this past week. The main takeaway is that while many different sources of supposed negative news arose, nothing really changed fundamentally about Bitcoin or its expectations for the future. The combination of many things happening at once, such as supposed bad news, exchange outages, and panic selling, caused the market to see a massive sudden sell-off.
Most of the sell-off was driven by newcomers in the crypto space that massively sold their holdings at a loss. The whales that are usually in it for the long term used this moment to increase their Bitcoin holdings. While this is not a guarantee that the market will immediately turn, it is an indication that the big players still want to accumulate Bitcoin for at least long term gains. This happens often with sell-offs: money changes hands to those with a long term vision.
Therefore, those that follow this model and have a main portfolio that is focused on the long term and use these opportunities to accumulate have increased chances of being successful in the long term.