The combination of high-risk leverage and widespread liquidations contributed to the crash in bitcoin’s price last week.
According to a new report by LongHash, investors over-extending themselves on high-risk leverage led to the cryptocurrency market crash on Mar. 12, during which bitcoin prices fell to $4,000.
Leverage allows clients to invest with borrowed capital on the future price of bitcoin, increasing the potential gains. However, it comes at the cost of a higher risk of liquidation, when a trader’s position is closed down in response to the market’s movement.
LongHash says over-extended leverage in the crypto markets, with some platforms offering 100x leverage on trades, created the conditions for Mar. 12’s meltdown.
The report reads,
These losses can have an outsized impact on the broader market because, for example, a trader with $1,000 trading at 100x is effectively trading $100,000 worth of Bitcoin. A few traders with a relatively small amount of money trading on high margins can thus create huge on-paper losses that push Bitcoin’s price down.
The report highlighted the influence of cryptocurrency exchange BitMEX on bitcoin’s price, which processes $2 to $4.5 billion in daily volume. BitMEX witnessed more than $1.4 billion in liquidations on Mar. 12, in part due to allowing clients 100x leverage, which contributed to the sinking price for bitcoin.
LongHash explained how the liquidations perpetuated the price fall,
The real problem occurred when the Bitcoin price declined below $5,000. The price drop was so intense that it left the order book on BitMEX virtually empty. As one cryptocurrency trader known as Lowstrife pointed out, there were $18 million of buy bids when the Bitcoin price was at $4,000s. But, there were approximately $200 million worth of sell orders left in the liquidation engine.
The report concluded that “unhealthy leverage” left the crypto markets highly vulnerable to an impending crisis, such as the economic uncertainty generated by the coronavirus.
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