The Breakdown - No, Bitcoin's Flash Crash Wasn't Caused by Turkey or Money Laundering or China or Any Other FUD

Episode Date: April 20, 2021

In 20 minutes on Saturday night, bitcoin’s price fell by more than 12%. Crypto Twitter raced to explain it as the byproduct of hashrate crashes after Chinese miners went offline, a suspicious report about the U.S. Treasury Department going after crypto money launders, and/or an upcoming ban in Turkey on using cryptos as currency.  NLW argues that all of those explanations are hogwash and that the crash had much more to do with leverage in the system than any fancy narrative. -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

Let's peel us all back again and ask what really happened, and this is where we need to make a really, really important shift, from thinking in terms of narrative causality to thinking in terms of market structure and technical causality. In short, we need to discuss leverage. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io. and produced and distributed by CoinDesk. What's going on, guys? It is Monday, April 19th, and today we are talking about this weekend's flash crash and why it wasn't caused by a Turkish ban on Bitcoin or the Treasury Department

going after money launderers or Chinese hash rate crashing or any other fud. And I want to start with a caveat that comes from a tweet from I Am Nomad. He wrote this weekend, Be careful of searching for narratives around, price. They are just people trying to stitch together a story that makes sense in their head. Much like the people creating them, they are usually wrong. So unless you are like camping in the titans with no cell phone access, you watched in horror or hilarity, depending on how much leverage you were using and how many market cycles you've lived through, as Bitcoin and literally everything else in the crypto market except Dogecoin absolutely hemorrhaged on Saturday night.

In the 20 minutes or so from 1115 East Coast time to 1135, the price of Bitcoin fell 12.3% from roughly 58,500 to 51,300. The derivatives markets were even crazier, with perpetual futures on Binance hitting a low of 50,500, and June quarterly futures trading as low as 35,000. The Twitterati, especially those a few degrees outside the actual Bitcoin industry, were rapid to the scene with their explanations. It was the upcoming ban in Turkey. It was a report about the Treasury Department going after money laundering that had happened via crypto. It was China mining going offline and a crashing hash rate. The point of my show today is not to argue that for some people, these factors didn't contribute to an overall sense of panic. But the directionality, I believe,

was the opposite of what people argued it was. In other words, it wasn't that people heard about one of these pieces of fud, sold their Bitcoin and pushed the price down. The price of Bitcoin went down, people tried to explain it with these factors, and some number chose to sell. Instead, my argument, which is really just the argument of most of the smart market structure people and traders, is that one, there was a run-up leading to Coinbase that we didn't really talk that much about with some specific exceptions, cough, doge cough, two, that run-up needed a pullback. Three, the market was characterized by an extraordinary amount of leverage that, when unwound, would inevitably have more dramatic impacts, and four, these fuds were there for convenient

narrative explanation. Before we get fully to that argument, however, let's discuss each of these different areas of fear, uncertainty, and doubt. And let's start with the one that is the easiest to dismiss. At 1042 on Saturday night, at FX hedgers, which is another one of these Walter Bloomberg style headline accounts, tweeted, quote, US Treasury to charge several financial institutions for money laundering using cryptocurrencies. Dash sources. Now, as you can see, the timing seemed to coincide with the aggressive part of the move. This came out about a little more than 30 minutes before that big leg down. Now, as you can see, the timing seem to coincide with the most aggressive part of the move down on Saturday night. The tweet came out

about half an hour before that 1115 starting point that I mentioned a moment ago. But friends, correlation is not causation. Every bitcoiner, hell, every even halfway skeptical person saw this and said, what sources is this account talking about? How much money laundering are we discussing? are the financial institutions they're mentioning crypto institutions or are they just using cryptocurrencies for this money laundering? And most of all, why is this breaking on Saturday night? Indeed, there are so many questions here that it made it very unlikely that this thing had the power to crash markets more than 10% in a matter of minutes. Subsequently, many publications have gone and tried to find what this account was talking about to little avail.

Now, one of the fuds that is a legitimate story, but with a highly sensationalized and questionable interpretation, certainly at least as it relates to this price crash, is the upcoming Turkey ban. To get a little bit of background on Turkey, I recommend you go check out my episode when currencies fail. Bitcoin Google searches and Turkey rise 400% as the lyric crashes. That story was from about a month ago at the end of March. It came on the heels of President Erdogan replacing a central bank governor with one of his loyalists. Now, the Turkish currency has had a difficult run and the same as true of Turkish assets. This governor, however, had done a good job to shore up those things vis-a-vis international investors. There was confidence returning to Turkish

assets. However, this confidence was based on aggressive interest rate increases. When that governor raised interest rates up another couple points to over 18, Erdogan had had enough and canned him. Immediately, the lira tanked, not only because of the potential policy impact, but also because this move so clearly undermined any semblance of independence that the central bank in Turkey had. Since then, the Turkish government has been aggressively trying to move money into native Turkish assets. This has been their playbook for a year or more, spending tens of millions to prop up the price of the currency, but this latest episode took on an even more urgent air. So what Turkey actually announced last week was a ban on using cryptocurrencies as a form of payment. But differently,

they didn't ban crypto trading. They didn't ban citizens from doing the thing that they've been using crypto for, which is to get the hell out of the lira. Starting on April 30th, cryptos just won't be able to compete with fiat as a payment mechanism. Of course, this hasn't stopped Turkish citizens being interested in the cryptocurrency space. Google searches for Bitcoin and cryptocurrency are up massively. What's more, trading volume in cryptocurrencies almost tripled to $2.8 billion between March 20th and 24th, up from $1 billion during the same period the previous year. Still, even though the ban wasn't actually a ban on trading or holding cryptos, it still rubbed some the wrong way. The leader of Turkey's main opposition party took to Twitter,

and criticize the government for it. He said that blockchain and crypto are the only areas where Turkey's unicorn ventures will emerge. He accused the government of having no tolerance for young people. So as you can see, this situation in Turkey is obviously worth watching, although it feels more likely to have a Streisand effect than anything else to me. It certainly does not feel like a credible explanation for a big market move. First of all, as I said, it wasn't a real ban in the pure aggressive sense of the word ban. Second, it's from a country whose currency has been failing, which is really important context. And third, Americans are incredibly solipsistic. Dalio can scream all he wants about the risk of banning and other countries can do banny-type things, but it won't rattle us until

it's actually coming from the U.S. But still, those weren't the only explanations of this flash crash that were offered from a narrative perspective, two more stories going around that were thrown up as part of the reasoning. The first has to do with Bitcoin's hash rate. Early on Saturday, Bitcoin Twitter came alive with discussions of the Xinjiang grid going down due to a major power outage from a coal mine explosion and the drop in hash rate that followed. In the morning, Nick Carter noted that the hash rate was down some 40% day over day according to the estimators, but much of that was likely variance. He said that seven days is the right time frame and Larry Sermak from the block argued that it's closer to 15 to 20%. What's important to remember in terms

of concerns and fud around hash rate is that the Bitcoin Protocol changes the difficulty of mining based on how much power is being thrown at it. It is a built-in mechanism to self-correct, and in this case, make mining easier given that there were now fewer machines on the network. Nick Carter also reminded readers that the Bitcoin hash rate already migrates between different parts of China based on the dry or wet season, and ultimately he called this a natural experiment to learn how much mining is actually in Xinjiang, pointing out that Bitcoiners are kind of already keen for less Bitcoin to be mined in that area already. Larry Sermak's on this up as lull, if you think the hash rate drop was the reason for the dump, you're not going to make it.

While Nidig said more politely, the reduction in the network cash rate does not seem to coincide with the timing of the sell-off. Looking for the best way to unlock your crypto's liquidity? Nexo.io is exactly what you need. Borrow against your digital assets at just 5.9% APR, earn passive income with yields of up to 12%, and swap between more than 75 market pairs with the instant nexo exchange. Try the Nexo wallet app to get the whole 360 degrees of crypto banking. Get started at nexo.io.

That leaves one more fud from this weekend that might have been offered as a possible narrative explanation for the crash. This one had to do with Coinbase and insider selling. Interestingly, while this was hugely discussed this weekend on Bitcoin Twitter, it wasn't really offered as an explanation for the Flash crash and, frankly, might have had a little bit more credibility if it did. Long story short, Coinbase direct listing happened last week. As I've said on every episode about this, direct listings are different from IPOs in a number of ways. One of those ways is that they don't

issue new shares. That means that the only shares that get sold have to come from existing shareholders. Existing shareholders are the liquidity providers in this system. Another way of saying this is that insider selling shares into the market was not only to be expected, without it there would have been no liquidity. That didn't stop a bunch of Twitter's resident trolls, including Peter Schiff, and the Archduke of the anti-antifragile ego, Nicholas Talib, to spout a bunch of stats about Coinbase's team selling everything they owned. Schiff claimed that Brian Armstrong was selling 71% of his shares, which is preposterous. In point of fact, he sold $2.91.8 million worth of shares, less than 2% of what he held. Both Fred Wilson and Union Square Ventures, as well as

Mark Andreessen and Andreessen Horowitz sold shares as well, but both continued to hold like more than 10% of Coinbase shares. The block put out research this morning that showed the actual percentage of total holdings sold. At the very top is Jennifer Jones, the chief accounting officer who sold 38.3% of her holdings. From there, it's less. Emily Choi, who's the president of the company, sold 24.4%. Alessia Haas, the CFO, sold 15.1%. Chatterjee Soroja, the CPO, sold 8%. Fred Ersom, the co-founder, sold 1.8%. And then there was Brian Armstrong, who sold 1.5%. Now, I understand why people wanted to be upset with this. Taleb played up the exact concern, tweeting that this was the opposite of skin of the game, get people pumped up and then

abandoned ship. Some even took this to the logical next step, arguing that that insider selling clearly meant that valuation was too high. Now, to be clear, this isn't totally insane. Increases in insider share selling is often a good leading indicator of a valuation being out of whack. But this was the first few days of trading of a company that has been illiquid for nearly a decade. This is a liquidity event. Liquidity events are designed to redistribute shares from insiders to the public market. That's literally their point. Without some amount of this selling, that would be impossible. What's more, this isn't Bitcoin. It's a private company with a lot of people who have been paper-rich, but not liquid for a very long time. So as you can tell, I'm not

particularly concerned about this. I did say, however, that in many ways this would have been a better argument for causing the crash than the other random fud we saw. What did I mean? Well, one of the big questions in crypto markets right now is what the narrative relationship between Coinbase and those markets is going to be. I talked about this event as a key test for this bull market and this is part of the reason. And indeed, you're starting to see mainstream media pieces pop up that make the connection explicit. Both MarketWatch and Bloomberg, for example, called this weekend a quote Coinbase hangover. It's just too easy a connection to make, whether it's true or not. So then the question becomes, is there a true part to this narrative?

Is there really a correlation between how Coinbase does and how the crypto markets go? Certainly, both BTC and ETH hit new all-time highs the day Coinbase went public, capstones of crazy 2021 runs. But remember, bull markets don't march straight up. 2017 saw something like seven corrections of more than 20% along the way to the all-time high that marked the psychological barrier that we were trying to return to for three years. Even in bull runs, markets get to natural exhaustion points. So ultimately, I don't believe that Coinbase's underwhelming performance, and certainly not its share selling, were the cause of

this sell-off this weekend. But I do resonate with the argument that at the prices we were at, we almost needed a huge lift from a crazy $100 billion valuation plus Coinbase to sustain ourselves without a reset. We didn't get that huge lift from Coinbase, and so the reset happened. But let's peel this all back again and ask what really happened, and this is where we need to make a really, really important shift, from thinking in terms of narrative causality to thinking in terms of market structure and technical causality. In short, we need to discuss leverage. Luckily, there has been a ton of great content on exactly this. Alex Kruger tweeted, any explanation for the crash must start with the leverage built into the system,

which had increased to extraordinary levels on April 9th. Then you can play with a lot of other variables such as treasury crackdown, miners going offline, exchange inflows, or an exchange failure. Leverage had gone ballistic full eight days ago. Nidig validated this point, saying in a research note, quote, we believe the root cause of selling had to do with investor positioning rather than fundamental news. Simply put, traders were over leveraged in position long, resulting in forced liquidation. Others like Sam Tribuko from Alameda got more specific. For the past week or so, crypto has been on a tear, he tweeted. It's risen slowly but steadily from the mid-50s to new highs over 65,000, seemingly without a ton of fanfare. Amidst excitement

over the coin direct listing, parts of this seemed almost inevitable. The coin listing came and went, and it's hard to say that it was anything but a pretty big disappointment versus the market's hopes, and certainly amidst the market's hype-driven rally. All throughout this big rally, there were a few weird things going on. Almost all the inflows were happening on futures platforms, and in particular on futures platforms with huge leverage, where the huge leverage has historically led to big liquidations. I'm sure everyone's heard how high the funding has gotten for various perpetuals products, and that signifies a ton of super-aggressive buying going on. So futures have been at, versus the recent past, unprecedentedly high premium and open interests are skyrocketing.

What is this set up? Things keep going up and up and up. Well, nothing. A bunch of agro buyers who turned out were right. But what if there's a reason for a small downturn? A reason like, I don't know, a super-hyped listing causing a rally and then falling short of the hype? I've seen a lot of complex theories for why crypto started crashing, but I don't really think you need him. Bitcoin rallied from 60,000 to 65,000 in the days pre-coin, fell to 62K quickly, and then, well, fell to 60K over the next weekend. Kind of no biggie in exactly what I'd expect. And so crypto falling a bit makes sense. What does that mean for all the superagro levered longs? Same thing it always means. They're getting liquidated and many billions of dollars did today. And this is the real nut

of it. It's back to NLW now. Over and over again, you see this point, this leverage, being pointed to as the catalyst for this big move. Investor Adam Cochran said this as well, quote, then you have the catalyst. This was the fact the market had been filled with FOMO and exchanges were allowing any retail user to use up to 100x leverage. We had a lot of crypto gurus promoting long-dead coins for massive pumps, and I'm talking about coins that I'm not even sure have development teams anymore. Meanwhile, many of them were hedging into cash positions. Here's how Cochran summed it up. What you have here is typical weekend behavior magnified by over-leverage new retail and a technical stress test fail.

leading to a perfect storm. No evil boogeyman banning or criminalizing crypto, etc. So if you weren't paying close attention, you might be wondering how much. If we're talking about all these leverage liquidations and the cascading impact they had, what actually happened? Well, we set a new single-day record. 864,000 crypto futures were liquidated, something between 8.5 and 10 billion in liquidations. I think to me, Joe Wisenthal nailed the significance of this, tweeting out, incredible sign of how big crypto and crypto trading have become over the last year. The dollar volume of leveraged long traders who got liquidated in last night's flash crash was more than twice as big as the crypto crash of March 2020.

Now, a couple days later, this is coming around to be the narrative. It's something of a wildfire narrative where these sort of crashes that liquidate the over-leveraged are an important part of the mini-market cycle. Raul Paul says, quote, I always feel relieved after these big liquidations of leveraged longs on crypto, cleans up the market. Mike Novograt said, with hindsight, it was inevitable. Markets got too excited about coins direct listing, basis blowing out, coins like BSVXRP and Doge pumping, all were signs that the market got to one way. We will be fine in the medium term as institutions coming into

the space. Chow Wang interestingly added a supercycle dimension to this argument. Quote, a lot of people are going to get burned by the supercycle idea. Not that it's wrong, but they'll think the market will just go up forever in a straight line and take excessive risk. Just be careful. The point that he's making is that even in the context of a new super cycle, there are going to be big corrections and serious volatility that, when combined with really leveraged traders could cause cascading liquidations in these sort of crazy price moves. Here's a bit of good news as well, however. The final words of Nidegg's research report about this were these. Quote, as final observation about the event, our desk has been a net purchaser

over the past 24 to 48 hours. Institutional investors have had a buy-the-dip mentality during these risk-off events suggesting increasing ease with handling Bitcoin's volatility. And that's the point I'll validate too. All of the people calling tops or squawking outsiders who sit around waiting for anything that proves their permanently bearish positioning. Everyone else handled these massive moves with a plum. We've now had numerous days of larger liquidations than we had on the then absolutely crazy crash of March 12th Black Thursday. The simple reality is that the market is getting more able to handle that. In that context, however, there are going to be more of these types of days. And while I obviously believe it's important to understand how narratives play into price

and especially long-term trajectories of markets, I don't think it's necessarily the right idea to immediately grasp for some sort of macro-narrative explanation for something which can be more easily explained by market structure and the behavior of traders. For now, guys, the party continues. Until tomorrow, be safe and take care of each other. Peace. We're witnessing the greatest paradigm shift in finance in modern history.

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