Lessons From the Crypto Crash
The market will self-regulate leverage ratios as longs keep getting rekt.
Earlier this week, May 19, 2021, the crypto markets got crushed. They had been trending down earlier on the week, but Wednesday was the worst by far. Here’s a snapshot from Wednesday’s bloodbath at roughly noon ET that day:
- ETH: -37% 7d … -25% 24h
- BTC: -28% 7d … -11% 24h
- AAVE: -23% 7d … -31% 24h
- XMR: -48% 7d … -35% 24h
- SNX: -23% 7d … -38% 24h
Not-So-Fun-Facts apropos the May 19 crash:
~$500B evaporated from the crypto aggregate market cap in a few hours.
AAVE lost $3 billion in liquidity. For a brief period, its DAI market only had $7M in liquidity (usually this number is several hundred million!), offering 66% APR on deposits.
Tether did not implode, shockingly, but stablecoin prices fluctuated wildly throughout the day. Screenshots on crypto twitter from the early morning showed USDT, DAI, sUSD, gUSD, etc… several hundred basis points off $1.00.
Coinbase, Kraken, Gemini, Blockfolio, and CoinMarketCap all went down for extended periods of time. (FTX stayed online, however). Also, while many centralized services got merkd by volume, not a single DEX went offline. Regulated CEX’s failed catastrophically, and unregulated DEX’s had no issues 🤔
Synthetix saw its native token price plummet, instigating a near run on SNX and sUSD liquidity across AMMs, as stakers rushed to either deposit more tokens into the contract to avoid liquidation, or un-staked and burned synths to repair their no-doubt plummeting collateralization ratios. Early wednesday morning, SNX deposits were sitting at 66% APR on AAVE, evidence of a very shallow liquidity pool.
The number floating around crypto twitter is ~$8B in liquidations in 24 hours across a number of exchanges.
So… Why?
The answer is actually pretty simple. The CCP said they would ban bitcoin, and Elon musk made an inane comment about bitcoin’s carbon footprint. This probably (and no one knows for sure), moved authentic price discovery down about 5–10%. These two events were not massive. Retail traders and institutions might have panicked, but most crypto veterans ignored the largely insignificant news. The problem is that a sudden high-single-digit drop was enough to start triggering liquidations, and a wave of liquidated longs dropped the price 1–2%, which triggered another wave of liquidations, which dropped the price again, and so on and so forth in a vicious cycle.
The explanation here is pretty straightforward: most big wallets who were long were reeeeaaallly long. Substantially levered. Overexposed. One big reason for this is the ease with which one can find on-chain leverage. Decentralized, on-chain lending and derivatives protocols will let you take out as many dollars in levered products as you can pay for, all without providing so much as a name or email address. There is no accredited investor check or credit inquiry. If you have the collateral, you can take out the loans.
This is the beauty of the wild west regulation-free crypto markets. No checks on leverage means that people who deserve to get rekt get rekt. There is no regulatory body which babies traders w/r/t leverage but simultaneously lets them YOLO their roth IRA balances into 3x long/short commodities ETFs.
Regulations in tradfi markets clearly exist to reduce volatility, not to protect clueless investors, and reducing volatility gives a false sense of security to speculators, which leads to massive bubbles. In crypto, bubbles form and pop within months. As open interest grows, the size of the drop it takes to liquidate them all drops. The crypto market can only get so long before it self-corrects. Minor news then triggers a sell-off and dog coin idiots and massively levered bitcoin longs get destroyed: the market self-regulates.
If you try to regulate the leverage ratios in crypto (pro tip: you can’t), you’re just benefiting the type of person who buys safemoon or dogelon or shib, because you don’t need leverage to gamble on those things.
