Unprecedented Shake-Up in Digital Currency Realm
On a recent trading day, the digital currency market experienced an unparalleled sell-off. This resulted in what has been referred to as the most severe liquidation incident in the history of cryptocurrency. This single event led to over $20 billion being wiped off the market as forced deleveraging set in and liquidity disappeared.
Impact on Perpetual Futures
Perpetual futures, commonly known as "perps" in the trading sector, are cash-settled contracts that don't have an expiration date. They mirror spot through funding payments rather than delivery. In times of financial stress, these contracts' profits and losses net against a shared margin pool. This often necessitates quick reallocation of exposure to maintain balanced books.
Bitcoin and Other Tokens Take a Hit
During this catastrophic event, Bitcoin's value plummeted 13% within a single hour. The losses experienced by lesser-known tokens were even more substantial, with some plummeting to nearly zero before managing to recover. The estimated total of open interest that was wiped out was around $65 billion, bringing positioning back to levels not seen since mid-2021.
Behind the Headlines: What Really Matters
The lead portfolio manager of a multi-strategy alpha fund argued that the headline figures are less significant than the market's underlying mechanics. During times of increased uncertainty, liquidity providers typically widen quotes or pull back to better manage inventory and capital. Consequently, organic liquidations stop clearing at bankruptcy prices, leading to the activation of emergency tools.
In such situations, exchanges have had to rely on safety valves. Auto-deleveraging was activated at some platforms, forcibly closing a portion of profitable counter-positions due to the insufficient cash on the losing side to pay winners. The manager also mentioned liquidity vaults that absorb distressed flow and make profits buying at deep discounts and selling during spikes.
What Worked and What Failed
Centralized venues witnessed the most dramatic disruptions as order books thinned. This is why lesser-known tokens suffered more significant losses than Bitcoin and Ether. However, DeFi liquidations remained relatively quiet for two reasons: leading lending protocols tend to accept robust collateral like BTC and ETH, and some platforms managed to limit cascade risk.
Despite remaining solvent, one digital currency traded around $0.65 on centralized exchanges due to liquidity issues. This made users who posted it as margin vulnerable to liquidation.
Hidden Risks for Market-Neutral Funds
The manager also highlighted concealed risks for market-neutral funds. He states that the real dangers on such tumultuous trading days are operational. This includes the functionality of algorithms, the reliability of exchanges, the accuracy of marks, and the ability to move margin and execute hedges timely.
Aftermath and Opportunities
Following the extreme lows, prices began to recover. This market reset has created opportunities for traders with available capital. The manager observed that with open interest significantly reduced, markets headed into the weekend on a more stable footing than the previous day.