The traditional markets’ recent sell-off drove cryptocurrency prices down, but the way it did so was more complicated than even many of the most sophisticated players in crypto were able to grasp. That’s because crypto’s drop was staged in the derivatives markets.
Financial instruments like futures and options make up derivatives markets, where value derives from, and is dependent on, the value of an underlying asset, in this case cryptocurrency. Coupled with a massive sell-off in the cryptocurrency markets, derivatives also contributed to recent declines in price.
In just 48 hours from March 7 to March 9, bitcoin (BTC) fell 17 percent from $9,215 to a fresh two-month low of $7,628.
As the S&P 500 tumbled 7 percent Monday, traders took to selling, not buying, crypto to deal with their own cash shortfalls.
“The crypto industry is reacting to the traditional market dump,” said Mostafa Al-Mashita of Secure Digital Markets, a Canadian crypto brokerage firm.
The effects of traditional markets on crypto befuddled many cryptocurrency stakeholders. Brian Armstrong, CEO of Coinbase, one of the most regulated and bank-friendly exchanges on earth, appeared to be taken aback at the way market dynamics within cryptocurrencies panned out.
What Armstrong and other long-view cryptocurrency holders perhaps don’t realize is the impact derivatives trading has on “thin” or low-liquidity markets like cryptocurrencies.
Selling pressure in cryptocurrencies can create a cascading effect that is hard to recover from. Traders on derivatives exchanges like BitMEX and Deribit must contend with auto-liquidation.
Such a margin call-like event happens after there is intense spot market selling of cryptocurrencies for much-needed U.S. dollars on exchanges like Coinbase.
“As people lose discretionary income and short-term liabilities get called in, all risky assets are correlated on the downswing for the short term and that includes both traditional markets as well as crypto,” said Kevin Zhou, CEO of algorithmic trading firm Galois Capital.
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