Bitcoin Plunges 18% In One Hour: Could Leverage Kill This Bull Market?

What happened

When Bitcoin (BTC 0.28% ) sneezing, other cryptocurrencies catch a cold. It’s like that. The world’s first and largest cryptocurrency by market capitalization, Bitcoin is often viewed as an indicator of the health of the broader crypto markets.

Early Saturday morning, Bitcoin fell about 18%, to reach $ 42,875 at 12:30 a.m. ET. This drop occurred over a period of one hour.

Since then, Bitcoin has recouped some of those losses, although the token remains significantly below the $ 55,000 to $ 59,000 range that the token traded for much of the past week.

Other major cryptocurrencies followed Bitcoin’s lead, selling spectacularly. The second largest cryptocurrency in the world by market capitalization, Ethereum (ETH 2.07% ) also fell to a one-month low at $ 3,525 per token, before recovering a significant portion of those losses.

This market-related crisis provided an opportunity to “buy the downside” for other high-flying tokens such as Earth (LUNA 0.89% ), which fell, but quickly reached new all-time highs as a result of this crash.

Image source: Getty Images.

So what

Many experts have linked what appears to be a lightning crash to the amount of leverage in the crypto markets right now. It is estimated that “only” 4000 BTC tokens were sold during this hour-long drop, with 1500 tokens sold at a time, triggering this crash.

Now 1,500 Bitcoin (at pre-crash prices) is roughly $ 78 million, and 4,000 BTC is roughly $ 208 million. For a token with a market capitalization that was over $ 1 trillion is stupid change.

However, crypto markets are known to allow higher leverage than other well-regulated markets, raising concerns that what should be contained, short-term price declines could lead to market contagion. .

The Bitcoin futures market is one of the first places investors go to assess leverage in the crypto world. Futures contracts are derivatives, like options, that allow investors to buy a particular asset at an agreed price on a future date. However, a smaller amount of initial capital is required to purchase these contracts, allowing investors to gain exposure to an asset significantly higher than the face amount of what they are investing.

In other words, Bitcoin futures allow investors to gain leverage, setting up lower initial capital to reap higher rewards, as long as Bitcoin prices rise. However, if prices fall sharply, investors can liquidate their positions to minimize losses, causing panic selling as investors seek to get off the ship.

Open interest in the Bitcoin futures market has grown in recent days, leading some to believe that leverage oversaturation may take place. So what appear to be large, but relatively small, Bitcoin sales appear to have resulted in these oversized moves, at least in part due to the leverage that has been building up in the futures markets in recent times.

Now what

There has been a lot of talk about record margin leverage in the stock markets lately. However, leverage in the crypto market appears to be a key factor that has just caught the attention of investors right now.

Given the recent developments we’ve seen with Bitcoin and the broader crypto market, investors have reason to be concerned about these recent violent movements in the price of what are said to be the most stable tokens.

That said, it should be noted that various cryptocurrencies have responded differently to the sale of Bitcoin. While most of the major cryptocurrencies were down, investors can cite specific high momentum tokens such as Terra Luna as examples of continued interest to ‘buy down’ among investors.

So, maybe this insane momentum that we have seen in the crypto space is not yet completely lost, just yet.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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