Bitcoin prices dropped by $3000 in hours, unexpectedly, last Friday. Many wondered about the sudden plunge considering Bitcoin ETFs in America have been seeing an unbroken run of inflows over nearly 20 days. I am going to share my thoughts on what could have caused this unexpected decline and what it might mean for the future of cryptocurrency since I have closely followed this market.
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To give you some background information, earlier this year the approval of bitcoin exchange-traded funds (ETFs) by the US Securities and Exchange Commission was a breakthrough for the cryptocurrency industry. These funds were started by big financial players such as BlackRock and Fidelity which made it possible for even retail investors to invest in Bitcoin without having to hassle with private keys or very long passwords that only someone with eidetic memory could remember. The effect on cryptocurrencies was immediate. Within weeks, Bitcoin gained more than half of its value and hit an all-time high of $73,800 as compared to previous levels. This was a remarkable accomplishment, particularly before the subsequent halving which usually drives up prices through diminished supply.
However, lately, Bitcoin’s price movements seem to indicate that the flow of ETFs is still what shapes its market behavior. In the middle of April and early May, when investors took away huge sums from these funds, bitcoin’s price took a dip. On the other hand, after inflows were resumed in mid-May; the market turned bullish again. This pattern stood up until last Friday when Bitcoin suddenly dropped from $72,000 to $68,500 in just minutes.
So what went wrong?
Since ETF flows cannot be blamed for this one time around, here are some community theories that have popped up.
One notable voice among them is analyst Willy Woo who posited that this drop happened because of over-leveraging within the system. According to him, many traders used excessive leverage to chase bitcoin prices thereby creating a risky situation where any major price movement could trigger off series of liquidations. Simply put this way: as soon as prices started to fall, these highly leveraged positions had to be mechanically closed out thus accelerating the decline.
Profit-taking is another theory floating around. Bitcoin was 2% short of its highest ever value meaning nearly all investors were profiting from it. This seemed like the perfect time for many to pull out, leading to a sudden sell-off. Though profit-taking is the natural part of trading, a massive amount of traders doing that at once can lead to a plunge in prices.
Liquidations resulting from this sell-off led to losses worth $400 million within 24 hours. It should be seen as an example for traders not to expose themselves through increased leverage especially in such volatile markets since overly leveraged positions can become a burden turning minor price drops into major financial disasters.
I consider this recent drop as a healthy correction going forward. The crypto market has been on an incredible rally, and a pullback could help stabilize prices and weed out speculative excesses which could form more solid ground for further growth in the future. Moreover, it is also important for us all to be careful and avoid getting carried away by the hype. Although the opportunity for high returns may seem tempting, so do the risks involved.