But in recent weeks, these kinds of price movements are occurring much more frequently. With the combination of new yet concerning consumer data from the U.S., including high inflation rates, together with rising tensions in Eastern Europe, the violent downwards reaction from the broader market does not seem to be out of the ordinary. However, what’s interesting is that asset prices have rebounded in a similar violent fashion soon after.
Bitcoin Historical Volatility Index, Jan 1 - Feb 28, 2022 (Source: TradingView)
As of late, liquidity for major cryptocurrencies such as Bitcoin and Ethereum is running thin, even on large centralized exchanges such as FTX. Could this be the main culprit, or perhaps there is more to the story than meets the eye? It’s time for us to investigate this theory.
The State of The Market
Bitcoin Price (1st Jan - 15 Feb 2022)
Over the past six weeks, Bitcoin has had a bumpy ride, going as low as $33,500 towards the end of January 2022. On separate occasions, we’ve seen significant dips of about 8-10% throughout January alone, particularly on the 6th and 21st, respectively. Clearly, there is still some strong correlation between the crypto and stock markets as the decline of US stocks on those days likely triggered a wider selloff for risk assets. Amid rising concerns of more hawkish decisions to come by the US Federal Reserve, wary investors were quick to flock to safer bets should their worst fears materialize.
Ethereum Price (1st Jan - 15 Feb 2022)
Ethereum’s journey was no different, sinking to as low as $2,200 on 24th January. Interestingly, both Bitcoin and Ethereum rebounded by 10% almost immediately, further cementing their tight relationship with the traditional stock markets, which also mounted a massive comeback to close in the green.
The market continued its slow grind throughout the Lunar New Year celebrations, inching closer and closer to $40,000. However, as January came to an end, Bitcoin faced multiple retracements as the price fluctuated between $36,000 to $38,000. From 25th January to 4th February, the trend frequently shifted, as BTC experienced surges in bullish activity only for the movement to retrace two days later. It was not until the next day that Bitcoin would buck the trend and finally break out again over $40,000.
With that being said, it's essential to understand why the markets have been behaving like this. Sure, there are several factors to consider, but some of them are simple to rule out. For example, massive plunges can usually be attributed to liquidation cascades, as the overall markets have become overly reliant on leverage, but this doesn’t explain the quick recoveries we’ve seen numerous times already this year. To get to the bottom of this, we look at a few possible scenarios that could potentially explain what’s really going on.
What May Have Happened
As we’ve mentioned previously, there are many elements at play that would affect the markets, and market movements are typically a result of a confluence of factors, instead of singular narratives. Here, we try to deduce what may be the primary factors that may have contributed to these recent drastic swings.
Overleveraged Markets?
When sharp drops tend to happen, we tend to be quick to point fingers at leverage being the main reason behind it. As prices dip, futures or perpetual contract traders on high leverage can be easily liquidated if they are unable to maintain the amount of collateral required. If the liquidation price is met, the exchange’s liquidation engine will begin selling off the traders’ position. As more traders start to get liquidated and more selling occurs, prices will dip even further, resulting in more liquidations. This ripple effect is known as a liquidation cascade.
BTC Futures Open Interest on CEXs (Source: coinglass.com)
As positions get closed during such an event, we typically see a drastic reduction in open interest, as was the case in May (Q2 2021 Report, slide 60) and early December (2021 Yearly Report, slide 45) last year. On both occasions, several billion dollars were cumulatively wiped from open interest, with major exchanges such as Binance and Bybit taking the brunt of the damage.
Yet, this was not the case in January 2022. Although some open interest was removed from the market during these major dips, it was not to the same extent as last year. At most, open interest dropped by approximately $2 billion during these price plunges, as compared to the $6 billion removed from open interest on December 5th, 2021.
Even if liquidations were the leading cause, it doesn’t really explain the abnormal movements in the opposite direction when markets rebounded swiftly. Massive upswings in price are usually attributed to overwhelmingly positive news or even a short squeeze, which weren’t present at that time. As such, we may have to look a little deeper at other aspects of the market instead.
Politics and Regulation?
Much like the stock markets (and despite what crypto maxis will claim), the crypto markets have followed the rhythm of the current political and financial climate. Historically from a macro perspective, encouraging consumer data paired with dovish monetary policy usually results in better performance for the stock markets and also, it seems, crypto markets.
While broadly correlated, it’s important to note that there is also crypto-specific news that affects the crypto markets. For instance, as more countries embrace digital assets and introduce healthier legislation, it would serve as a strong catalyst for increased demand. On the other hand, unfriendly regulations and authorities repeatedly calling for cryptocurrency trading to be outlawed would paint the markets red.
As the crypto markets never sleep, new information and regulatory developments are being absorbed by market participants in near-real time and subsequently converted into trading decisions. This results in near-instant pumps and dumps as the market reacts almost immediately. Ultimately, we would see extended periods of volatility if there is a constant stream of information for traders to take advantage of, as was the case for the past few weeks. As such, we have reason to believe that the political and regulatory landscape has also affected the trend of the markets in a significant way.
Reaction of Bitcoin Price to News (Jan 1st - Feb 15th 2022)
A few examples could be seen from 3rd to 11th February. On February 4th, job reports for January showed strong signs of an improving economy. Payrolls rose to 3x the Dow Jones estimate, paving the way for Bitcoin to break past the $40,000 barrier. On 10th February, the release of a much higher gain in CPI than expected had once again stoked the fear of inflation in the market as some investors quickly risked off. However, this was short-lived, as those who believed in Bitcoin’s purpose as a weapon against inflation, promptly ate up the dip, briefly sending it above $45,000. But clearly, this was not enough as the sell-off on equities and other risk assets resumed, fueled by rising political tensions between Ukraine and Russia.
Thin Orderbooks?
It’s hard to deny that the size of the crypto market has grown to immense proportions in 2021, and we are starting to see much more volume being traded, especially the top cryptocurrencies that are available to most of the general public. Yet, it’s already starting to look different in 2022.
Global Crypto Market Cap and Volume (Jan 2021 - Feb 2022)
On April 7, 2021, the global crypto market cap broke past $2 trillion, while trading volume stood at $266 billion, or about 13% of the total market cap. Back then, Bitcoin was trading at $58,000, still on its ascent to $60,000 and beyond. Even though a year has barely passed, the market cap is now back at $2 trillion on February 7, 2022. However, the total volume traded is only $69 billion - only 3.5% of the total market cap, representing a 70% decrease.
Coupled with a much smaller amount of trading volume, we have observed large fluctuations in the price of Bitcoin, Ether, and other large-cap cryptocurrencies. These assets have relatively deep liquidity on centralized and decentralized exchanges and are generally the most accessible to the retail crowd. Although that used to be the case, it is looking as if it does not take much to push these tokens to all-time highs or to dump them into the ground. In other words, order books are getting thinner, and it’s hard to ignore the evidence.
Bitcoin Exchange Netflow (Source: CryptoQuant)
Based on Bitcoin net flows from last year to now, it is quite apparent that volume is steadily grinding down, even if the prices aren’t far off. In February 2021, inflows and outflows of Bitcoin were significantly higher compared to February 2022, although they were at a similar price range. Even as Bitcoin rebounded back above $60,000 in October 2021, the volume of BTC moving in and out of exchanges was already considerably lower compared to 8 months earlier.
Stablecoin Reserves on Exchanges (Source: CryptoQuant)
Stablecoin reserves on exchanges continue to trend upwards, yet demand is almost non-existent. At a glance, the total bids on Bitcoin perpetuals on FTX were just over $368 million. The spot markets are even thinner, amounting to a total of around $243 million across the USD and USDT pairs. As one of the largest crypto exchanges, having such a concerning ratio of stablecoins to bids is perhaps an indication that many traders are just staying on the sidelines for now and waiting out current market uncertainties. For further comparison, below are some snapshots of the order books on other major exchanges as of 15th February, which may be inaccurate due to spoof orders.
|
Markets
|
Spot BTC |
BTC Perpetuals |
||
| Bids ($M) | Asks ($M) | Bids ($M) | Asks ($M) | |
| Binance | 26 | 27 | 34 | 40 |
| FTX | 243 | 145 | 368 | 188 |
| Kraken | 50 | 41 | 31 | 16 |
| Bitfinex | 74 | 80 | 12 | 163 |
Exchange Orderook Snapshot, 15th February 2022 (Source: CoinGecko Analysis)
To put into perspective, public listed companies such as MicroStrategy and Tesla could have easily purchased more than those amounts, although these deals would normally be done over-the-counter. Even so, it may be challenging for the current state of the order books to sustain the impending entry of fairly large institutions, all of who are eager to get a slice of the pie. Assuming that someone buys or sells a sizeable position, it is no surprise that the market will swing erratically due to low liquidity. This may well be another one of the primary reasons behind the price movements that we’ve observed so far in 2022.
Closing Thoughts
It is clear that the turmoil in the markets has been brought on by a combination of a gradually declining well of liquidity and a constantly shifting political landscape. The constant stream of new governmental actions and policies that tend to be divergent in nature results in a more volatile market, where price reactions are exacerbated by a thinning order book.
But why exactly are the markets drying up? Just a year ago, liquidity was deep enough for buyers and sellers to cushion the pressure even without tilting the market too much in either direction. Now, we easily see 5-10% price movements within a day for even the largest cryptocurrencies.
Perhaps, politics and regulations are the root causes of that very issue. The ongoing geopolitical turmoil, as well as macroeconomic risks as countries seek to combat the effects of excessive money printing and inflation, are not exactly a healthy environment for the growth of crypto markets. With authorities constantly on the fence regarding cryptocurrency, the near future has become less predictable, and participants are becoming warier. In such circumstances, the growing uncertainty has driven most to remain on the sidelines. As the markets continue along their winding path, one can only imagine what will happen if more chips leave the table.
Win Win is an avid gamer, interested in navigating the vast world of NFTs and the cryptoverse. Entering the crypto space in 2020, Win Win focuses particularly on DeFi and GameFi, looking out for the latest developments and projects in the space. The author has lived through the meteoric rise of DeFi as well as the collapse of Terra and FTX. Follow the author on Twitter @0x5uff3r
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