Key Insights
- •The crypto market experienced a rapid decline during the November crash, mirroring the synchronized movement of stocks and cryptocurrencies.
- •A stablecoin pricing error and high leverage levels may have amplified a normal dip into a significant market fall.
- •Gold saw a surge in strength, while whales engaged in selling during the downturn, indicating a potential shift in capital flow during periods of market fear.
The cryptocurrency market experienced a sharp downturn this week, with both global stocks and major digital assets declining simultaneously. The US stock market alone lost nearly $1 trillion in value within a single day.
The total market capitalization of cryptocurrencies decreased by approximately $120 billion. Bitcoin's price saw a decline of around 7%, and Ethereum also dropped by approximately 7%.
This sudden and steep fall differed significantly from typical market dips. Its speed and apparent manipulation led many traders to question whether the cryptocurrency market is facing deeper, unnoticed issues.
Stocks and the Crypto Market Fall Together as Correlation Rises
A notable shift observed is the increased correlation between the cryptocurrency market and the US stock market. Correlation is a metric that quantifies the degree to which two assets move in relation to each other.
A correlation coefficient close to one signifies that the assets move in the same direction. A value near zero suggests random movement, while a reading below zero indicates they move in opposite directions.
In September, Bitcoin and US stocks exhibited diverging price movements, with a correlation below zero. However, this figure has now surged to approximately 0.78.
This elevated correlation implies that both markets are now moving in near-unison. When stocks experienced a selloff this week, the price of Bitcoin also fell rapidly.
This trend subsequently pulled the rest of the cryptocurrency market lower.
Another significant change is the relationship between Bitcoin and gold. For an extended period, gold and Bitcoin had been rising in tandem, particularly during times of global uncertainty.
However, their correlation has now fallen below zero, indicating an inverse relationship.
This means that gold is appreciating in value while Bitcoin is depreciating, suggesting gold is once again functioning as a safe-haven asset and prompting investors to re-evaluate their portfolio allocations.
This shift implies that during periods of fear and uncertainty, investors are favoring gold over cryptocurrencies. This raises the question: is the market's risk appetite turning decidedly "risk-off"?
What May Have Started the Crypto Market Drop?
Several key factors appear to have contributed to the rapid correction observed in the cryptocurrency market.
One primary factor was a stablecoin pricing anomaly. Stablecoins are digital tokens designed to maintain a stable value, typically pegged to a fiat currency like the US dollar.
On certain trading platforms, a software glitch caused the price of a stablecoin to briefly dip below $1. Even minor errors of this nature can trigger cascading effects within automated trading systems.
Numerous trading bots can react in unison to such discrepancies, leading to sudden and widespread selling pressure.
A similar incident occurred on October 10th, which resulted in one of the largest liquidation events in the history of the cryptocurrency market.
Liquidation occurs when a trader who has borrowed funds to increase their exposure (leverage) experiences losses that exceed their margin. The system then automatically closes their position to prevent further losses, which adds to the selling volume and pushes prices lower.
The recent stablecoin error reignited this pattern, creating a chain reaction that impacted Bitcoin, Ethereum, and other major digital assets.
According to Tom Lee, an analyst at Fundstrat, this reaction might be nearing its conclusion. Another significant observation relates to the nature of the selling activity.
While initial reports suggested retail investors were selling their spot Bitcoin and Ethereum exchange-traded funds, subsequent data indicated that large wallet holders were the primary sellers.
These larger entities hold substantial amounts of assets, and their selling activity can accelerate price declines.
Spot ETFs also experienced outflows, suggesting that major institutional investors were reducing their exposure during the market downturn.
The drop was further amplified by the prevalent use of leverage in trading. Leverage involves using borrowed funds to increase trading positions.
When the market moves against leveraged positions, traders face rapid liquidations, exacerbating price drops. Galaxy's latest report indicates that leverage in the cryptocurrency market has reached an all-time high of $73.6 billion.
However, a key difference this time is that the majority of this borrowing is backed by Bitcoin and Ethereum, unlike previous years where riskier altcoins constituted the bulk of leveraged loans. This shift towards more established assets makes the market cleaner and easier to monitor.
Nevertheless, when the cryptocurrency market experiences a downturn, these leveraged positions are closed simultaneously, contributing to the appearance of a mechanical price decline.
What’s Next as Risk Continues to Hover?
As evidenced by recent events, the cryptocurrency market remains highly susceptible to sudden shocks. Despite increased transparency, stress events continue to exert significant pressure on the system.
Furthermore, gold's resurgence as a preferred safe-haven asset suggests that during periods of market fear, investors may prioritize reducing their exposure to cryptocurrencies.
Collectively, these indicators point to the cryptocurrency market grappling with a confluence of challenges. Stock markets are declining, gold prices are rising, leverage remains elevated, and stablecoin infrastructures continue to exhibit vulnerabilities.
When these factors converge, even minor disruptions can trigger substantial market downturns. The November drop serves as a stark reminder of the market's ongoing sensitivity.