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How Crypto Market Structure Broke



At 12th March 2020 we lived a very extreme situation in crypto currencies market. Let me tell you what happened and why the market broke.

A brief introduction about the crypto market structure

In crypto currencies markets there are 2 types of exchanges. The first one is spot exchange (you buy real bitcoin) and the second one is a derivatives exchange (futures market). In the spot market in order to buy one bitcoin you need to deposit fiat currency (EUR,USD etc). But in the futures market you can speculate about the bitcoin price or other cryptos, depositing bitcoin as collateral. The value of the collateral will increase/decrease with the price of bitcoin.

Let me give you an example

If someone deposit 10 bitcoin to a futures exchange and go long 100K perpetual contracts with price at 5200,he will get liquidated when bitcoin price goes below 3430. If the same person goes short 100K perpetual contact with price 5200, he will get liquidated when bitcoin price goes above 10660. These price targets will adjust for every bitcoin price move.

Whenever the price of bitcoin goes down, the same will happen to your collateral value of 10 bitcoins that you have deposit. This means that the price of liquidation will go up every time the price of bitcoin goes down, if you are long. But the opposite is not true. If you are short, the liquidation price will not go down at the same pace, because your collateral increased in value. This is very important to understand because it played a crucial role in this market collapse.

Arbitrage Bots

There are many exchanges and even though prices are different around them, all of them are connected by arbitrage bots or market making bots. So for example, if price falls at one exchange significantly, it will fall in all others too. And now starts the good part. Everything started when the stock market was going down because of the coronavirus fears and everyone was trying to get liquidity.

Institutions sold everything they could to cover their margin requirements. This panic started to hit crypto market as well and institutions trying to sell their risk assets because bitcoin is a risk asset to them. The price started to fall and many long liquidations starting to pop up at derivatives exchanges. At first there were enough market makers in order to absorb the selling pressure. You need to know that at least 47% of the crypto traders (based on reports) using Technical Analysis in order to use their stop losses etc, this means that if some price target gets hit, a massive amount of stop losses or hedging orders will hit the market.

A brief introduction about the crypto market structure

This happened when bitcoin price dropped below 7100 usd. After that price breached, there was chaos. Because all these stop losses started to hit the market, price dropped really fast and market makers couldn’t hedged their long positions. Because they couldn’t hedged, market makers were very near the liquidation price of their positions. They were starting to deposit more bitcoins at futures exchanges in order to meet their margin requirements. This triggered a huge pressure at bitcoin network confirmations time. In a normal day a person could move his bitcoin to a futures exchange in 10-30 minutes top.

In 12th March confirmation time increased to 6-8 hours. Even though market makers had the money to send in order to cover their margin requirements, they couldn’t deposit in time because their transaction needed at least 6 hours to get processed. Because of that the last domino of liquidations stated to trigger. Market makers where whipped out and started to get liquidated. This created a huge structural problem because now there wasn’t anyone to place bids in order to buy these huge amount of liquidations. The whole market started to collapse , every bot was starting to follow the prices at futures markets and starting to sell at spot market. This vicious cycle could not end, because Bitmex (the biggest crypto derivatives exchange in the world) had more long liquidation volume than all the bids in his orderbook!!!


If Bitmex didn’t pull the plug

It was 100% sure that bitcoin price would went to zero if Bitmex didn’t pull the plug and closed down their exchange for “maintenance” reasons. When Bitmex website went down, bitcoin price instantly spiked to the upside and recover more than 1500 usd. After 30 minutes Bitmex was live again and the price started to collapse. They still had too much volume to liquidate. They tried to not post the liquidation orders on their orderbook at mass, in order to create a fake feeling that it was over. They tried to close the positions in small amounts in order to not scare the market again.

When the panic stopped Bitmex orderbook depth [10] (the 10 top orders in bid and ask) had 1 million cumulate volume, before the panic there was at least 10 millions. The biggest derivatives exchange in crypto market had lost 90% of his daily volume. Because of that, Bitmex market was vulnerable in market manipulation with very few money. With a method called spoofing, market participants could create the illusion that there is a lot of volume in one direction in order to push the price up or down. They were started to play the chicken game. Here is how the game is played. Let’s say that the last price is at 5220.

A participant is placing an order of going long 100K with price at 5200. This will create an illusion that there is an interested buyer at that price. Trading bots read this volume and they adjust their offering prices accordingly. So, selling bots cancel their previous order and place the new ones a little bit above their previous price. Buying bots reading this pattern and they increase their prices also. This creates an illusion that there is buying interest and the price goes up a bit. When the prices shift in participant’s favor he can close the order of 100K at 5200 and replace it at 5210. If the participant can do that for hours he can stabilize the price or push it up. That way you can manipulate the trading bots in Bitmex orderbook. If you combine this technic with the liquidations, you will get a vicious cycle until a huge order comes from the other side of the trade.

Maker DAO

The most extreme situation happened to decentralized exchanges and decentralized collateral applications. There is a project named Maker DAO in which you can deposit Ether (Ethereum network currency) and get a stablecoin named DAI (it is a crypto currency which tries to mirror USD price using arbitrage mechanism). When you deposit Ether at the platform, you can get up to 70% of the Ether price in DAI. If for example the price of Ether is 200 and you make a deposit of 1 Ether, you can get up to 140 DAI. If the price of Ether drops below a threshold you MUST deposit more Ether in order to not get liquidated and lose all your Ether that you have deposited.

When you cannot deposit more, your Ether will get sold to the participant that offers the biggest price in order to buy your Ether. When the selling chaos started, there were no market participants left with money in order to buy 8 million of Ether liquidations. At that time a person posted an offer to buy 35K Ether with the price of ZERO!!! The mechanism accepted this person’s offer and now he/she is a millionaire!!!

In conclusion, even though the bitcoin network proved very strong in this chaotic environment, the markets that trade bitcoin did not. Crypto currency markets are still very immature with a huge design flaw, letting people to go long bitcoin price with bitcoin collateral is a huge mistake for bitcoin price stability relative to usd.


Makarid is a software developer for cryptocurrency financial markets, cryptocurrency enthusiast, and deep learner in financial markets structures and functions.