Many of you probbaly have painful memories of Bitcoin’s 50% flash crash on March 12.

Well, on Monday (March 30), Coinbase talked about this crash, as well as how its users reacted to this event.

The question that Coinbase’s blog post attempted to answer was the following: if Bitcoin is an uncorrelated asset that is meant to act as a “safe haven” during times of turmoil, why did the Bitcoin market still crash 50% (“the single largest one-day drop in Bitcoin’s price since 2013”)?

Coinbase started by presenting the context for this event.

Just one day earlier, World Health Organization (WHO) had announced that “COVID-19 can be characterized as a pandemic.” 

We also had President Trump’s “30-day travel ban between the United States and Europe” as well as Italy’s Prime Minister putting his entire country on lockdown. 

Coinbase says that the growing realization that the “global economy was not in a place to adequately handle the shock” resulted in a huge crash in the traditional financial markets, with “the S&P 500 and DOW Jones dropping nearly 10% in the biggest one-day slide since the Black Monday crash of 1987.”

So, here is what happened on March 12, according to Coinbase:

“When investments sharply fall, investors naturally seek out ‘safe haven’ assets — things that will not lose their value (usually USD).

“But everyone rushing to the exit at once produces a liquidity crisis, where the number of sellers far surpasses the number of buyers, which further drives prices lower and lower.

“To add insult to injury, many large asset allocators held leveraged positions, where only $1 of real value was backing ~$2-$3 of borrowed value.

“When markets crashed, these leveraged positions were in jeopardy of becoming insolvent and being forced closed, further placing a premium on USD.

“The general sell-off combined with a massive deleveraging event resulted in an intense rush for cash.

“In these moments, investors do not sell what they want to sell, they sell whatever they can. This includes Bitcoin and other cryptocurrencies, but every liquid market saw deep losses on March 12th.”

More specifically, in the case of Bitcoin, the reasons for the crash were quite similar:

“Some short term speculators sold, some institutions required cash for margin calls elsewhere, and some leveraged positions were forced to close.

“But it dropped harder and faster for Bitcoin than traditional markets for one central reason: the size and scope of leverage in the Bitcoin industry.”

Coinbase points out that although “traditional equities markets limit the amount of leverage to ~2–3x,” there are offshore crypto exchanges that offer leverage as high as over 100x. THis is highly risky since “a position leveraged to 100x would get force-closed if the market moved just ~1% against you.” 

In the crypto space, there is also other types of leverage: “miners often collateralize loans with Bitcoin, lenders offer cash loans for BTC deposits, and more advanced traders use leverage for futures contracts.”

Just before the crash, the total size of “all leveraged contracts on exchange-based products” was approximately $4 billion, which was large enough to mean that “any appreciable drop could induce additional shocks to the price.” 

Although such large drops usually result in buyers moving in to do some bargain shopping, on this date, the degree of panic was so high that it turned buyers into sellers:

“As prices drove lower, more leveraged positions were forced to close. Each new sell was met with tepid buying, dragging the price again lower, resulting in more liquidations. A cascading effect.”

The crypto exchange where these “cascading liquidations” were most evident was BitMEX:

“Amidst the selloff, a Bitcoin on BitMEX was trading well below that of other exchanges. It wasn’t until BitMEX went down for maintenance at peak volatility (citing a DDoS attack) that the cascading liquidations were paused, and the price promptly rebounded.”

Although the price of Bitcoin briefly dropped below $3,500 on some exchanges, within hours, Bitcoin had bounced back to the mid $5000s.

So, how did Coinbase users react to a flash crash that was “driven by a broad liquidity crisis, exacerbated by extreme leverage in crypto”?

Coinbase says that in “the 48 hours during and immediately following the drop”, it saw “record-breaking numbers” (compared to its “last 12-month averages”):

  • “5x increase in cash and crypto deposits, totalling $1.3B”
  • “2x increase in new-user signups”
  • “3x increase in trading users”
  • “6x increase in total traded volume”

There were two things that Coinbase very interesting:

  • Coinbase users were buying during the price drop; and
  • Coinbase users’ focus of attention was mostly on Bitcoin (as opposed to other cryptoassets available on Coinbase), with “over half of both total deposits and trades” being in Bitcoin, but Ether and XRP “saw increased traction too.”

Coinbase closes its blog post by noting that “since the drop, Bitcoin and the broad cryptocurrency ecosystem has rallied while equities have continued to drop (S&P -6% vs Bitcoin +23% as of March 27th).”

Coinbase appears confident in Bitcoin’s value proposition:

“Bitcoin was created for a moment like this… 

“And as the US government turns to slashing interest rates, passing large stimulus packages, and infinite quantitative easing, Bitcoin will soon do the opposite in the next Bitcoin halving…

“Ultimately, Bitcoin’s value prop should not be defined by extraneous market dynamics, but rather by its unique properties that make it a potentially attractive store of value.”

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