The Breakdown - The Real Story of the Crypto Crash Isn't about Elon or China

Episode Date: May 21, 2021

In this episode of “The Breakdown,” NLW looks at the market structure dimension of the crypto crash, leveraging insights from Alameda Research, Willy Woo and many more. He explores:  Why the recent bull run was driven by derivatives more than by spot trading How crypto moving onto exchanges signaled the big move down How cascading liquidations made the down moves even more extreme  What the industry thinks about 100x leverage Insider reports on how institutional investors responded CoinStack newsletter referenced in the show: https://coinstack.substack.com/ -- 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

To be clear on the scope of these liquidations, I gave you the broad numbers yesterday, the aggregate approaching $10 billion. But to me, the bigger crazy number is 775,000 traders who had their accounts liquidated. That is a huge move. And part of what made this extra crazy is that, on the way down, the apes kept opening up levered longs trying to catch the bounce back and then getting those liquidated as well. So even the attempts to counter the move down ended up contributing to the overall picture. 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 nexus.io and produced and distributed by CoinDess. What's going on, guys? It is Thursday, May 20th, and man, we had a hell of a day yesterday, truly one for the record books. I think I read it was Eith's second worst day on record. It saw Bitcoin touched lows that it hadn't seen since February, and the dynamics of the crash were particularly shocking. It was like watching the freefall of this entire industry. Yesterday felt like some combination of people scrambling to get out, people scrambling to get in,

people scrambling to explain which fud it was that had caused this thing, and then, of course, people scrambling to make their prognostications about where we go next. Now, however, we've had a full day, which is the crypto equivalent of a week in normal markets, under our belts. We've recovered a lot of the losses. Bitcoin is literally all the way back at 42,000, where it started. We've reset our positions and we've had a chance to more dispassionately explore what happened. If you listened to the show yesterday, you heard me go through each of the big areas of fud and argue that the issue ultimately wasn't any one of those concerns, but an overall market narrative fatigue, nervous newbies, and liquidations that made everything more.

extreme. Today I want to expand on that using a ton of great analysis from others, and the main point that I want to make is to demonstrate how much of these types of moves are shaped by market, structure, and setup rather than big narratives. At the end, I'll come back and explain where I think narratives actually fit. So let's start with the setup. Sam Tribuco from Alameda Research did a mega thread about this that I will reference quite a bit. He starts by pointing out that what was clear was that the narrative driving the upswing in the winter was all about institutions getting into Bitcoin, and in the spring it was the notion that many of those same institutions were starting to turn to ETH. But then he got to the inflection point and said, quote, which coins are rallying

isn't all that matters, though, and understanding reasons for the buying isn't enough either. We need to go deeper. I saw a ton of speculation that the rallies, especially the ETH rallies, were low leverage and spot driven, and therefore, quote, more organic somehow. An important implication of that is that, in the event of a downturn, there'd be relatively few liquidations. That narrative was super wrong, though, and it was possible to know that. How? Well, this narrative has basically been true zero times in the past three-ish years. You can tell from the fact that all the volume is in derivatives or spot where the exchanges allow leverage. Now, the point Sam goes on to make is that this was not institution spot buying Eth to drive up the price, just like it wasn't exclusively

institution spot buying Bitcoin to drive up the price. It was also traders going long with leverage. As he put it, quote, this was all on leverage, just waiting for a day like today to come along. Alex Kruger validated this as well, saying, quote, leverage in crypto has been above historically sustainable levels since early December. So if you were the kind of trader that fully exits a directional trade or asset class because too much leverage, you would have been flat since Bitcoin 20K and ETH 600 or so. Coin Gecko's Bobby Ong followed up saying, Alex said things very well. I've been monitoring the funding rates, to check on leverage too, and it has been super high for a very long time. The party went on and on and on

searching for a trigger to truly unwind and finally found it with Elon and China Fudd. We'll come back to what happened next in a minute, but first I want to bop over to Willie Wu for more on the immediate term setup. This is from Willie's note on the 18th, and he said, quote, exchange flows are showing tidal waves of coins flowing into the exchanges. Whales are dumping out, but unlike last time, it's unmet by dolphin and shark buying. Invitational. Invitational, at the exchanges are climbing quite steeply. Must get the fud at a glorious time to knock the price. As it turned out, a lot of the new buyers were prone to fud. The dormancy these coins are carrying have very little aging in the wallets. It's saying to me noob and skittish high net worth

individuals and institutionals are selling. Okay, so now we are starting to get the real picture. We've got a leverage-driven bull run with fading momentum, more than a healthy dose of fud, and perhaps an audience of new buyers a little bit more receptive to that foot. Finally, we have coins being moved onto exchanges setting us up for what happened next. 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. So let's get to the postmortem of the specifics of yesterday's crash. This is the write-up from Ryan Alice who writes the Coinstack newsletter. Quote, at 1230 a.m. UTC yesterday, May 19th, everything was looking okay and Bitcoin was trading at 42K and Eith was at 3.4K. Other than having a rough weekend due to Elon's tweet storms and some incorrect China flood recycled from 2017, things were generally okay in crypto markets. At exactly 1240 a.m. UTC, Wales moved a net of 500,095 ETH onto exchanges to sell. At the time, this was

1.65 billion worth of ETH. This caused the Eth price to drop from 3,391 to 3,091 to 3,09 within 6 hours. At exactly 6.30 a.m. UTC, Wales moved a net of 13,55 Bitcoin onto exchanges to sell. At the time, this was 535 million worth of Bitcoin. This caused the Bitcoin price to drop to 37,976, which further led the ETH price to drop from 3,09 to 2651 within five hours. Investors in Europe and the USA began waking up, saw the price declines and got fearful. Once the price points of 38,000 BTC and 2.5K ETH broke, cascaded liquidations started piling up, forcing those with leverage to auto sell at market prices and bringing down the Bitcoin price from 38,000 to 30,000 and ETH to 1.8K within 60 minutes

around 1130 UTC. This was around 7.30 a.m. Eastern time in New York. City in 430 a.m. in Los Angeles. Sam Tribuco again reinforced this broad analysis. Remember, he said that this was just waiting for a day like today to come along. Quote, and come along it did. When there's a big one-directional move with lots of agro positions getting opened and then there's a small reversion, liquidations create momentum and make it a big reversion. Whatever caused the initial market-wide crash, probably a lot of Elon with some China and other vague regulatory news thrown in, or maybe it's a natural correction. It happened,

and liquidations did a lot of the work of making the downturn more intense. Back to NLW again, and to be clear on the scope of these liquidations, I gave you the broad numbers yesterday, the aggregate approaching 10 billion. But to me, the bigger crazy number is 775,000 traders who had their accounts liquidated. That is a huge move. And part of what made this extra crazy is that, on the way down, the apes kept opening up levered longs trying to catch the bounce back and then getting those liquidated as well. So even the attempts to counter the move down

ended up contributing to the overall picture. Now, there is another dimension of this story as well, which has to do with the infrastructure of the market. First, the good news. Mike Busella from Block Tower said, quote, yet another stress test of the nascent crypto market structure. The positive note here was the resilience of DFI protocols, namely AVE and Comp, where they bent but they did not break, something that crypto community can certainly feel good about. Crypto Cobain put it more simply. All of Defi not completely house of cards collapsing and self- imploding during the whole thing was actually a better outcome than expected. However, that was about where the good news ended. In the centralized exchange world, exchanges were absolutely hammered. For a while, it felt like

no one was up and running. Coinbase certainly was throwing error screens for hours. Ryan Selkis tweeted out, a big reason that sell-off was so bad was because none of the OG buyers could access their fucking trading accounts. Not naming names, but that's frustrating. In other this was a systemic infrastructure failure even more than it was a mass panic. Unfortunately, the decentralized exchanges weren't necessarily much better. They kept performing, yeah, but fees were off the charts to execute trades. And all of this had specific consequences. There was a multi-hour period where people who would have been absolutely gobbling the dip

simply weren't able to. However, as we've seen, there has been a great recovery. In fact, I joked on Twitter, if you had been a Bitcoin or out camping for the last 36 hours or so and just now looked at the prices, you wouldn't even necessarily notice that anything had gone wrong. So let's explore a couple more dimensions of this. The first is this idea of leverage. Is it a good thing?

Cedderas Paribis tweeted, seriously, though, this market will never be taken seriously until we stop offering 100x leverage. It's fucking stupid. Chow Wang said, I used to be adamant about 100x leverage being detrimental to this industry, but now I also think it is what a true free market looks like. Hard to say if it's a net positive or negative. Pros and cons. For what it's worth, I don't think most people should use leverage. Personally, I almost never use leverage on a 150-vall asset,

and when I do use leverage, it's really for the asymmetry versus leverage, i.e., I used options, but to each their own. In a piece about meme coins on Bloomberg, Nick Carter puts it really simply, quote, it's more aggressive capitalism than we've ever seen. So as you can see, you really can't tell this market story from a purely narrative perspective. Sure, Elon and ChinaFud might have been a little bit of a catalyst, but we have to understand how the specific market instruments being used to play these markets contribute to the nature of the moves. And if there is a TLDR, it's that they have a hyper-accelerationalist impact on both the up and the down swing. But you might be wondering how these words are coming from my mouth, given how much I talk about narratives. I obviously think it's really important to understand narratives, but to do so, we have to understand what type of power they have and don't have.

Let's use an example to make this point. Last week when inflation numbers came out, Bitcoin didn't move. In fact, it went down. If you were on Twitter, you probably saw a bunch of Bitcoin permabairs saying something like her-her so much for your inflation hedge. But even outside of those bad faithers, I had plenty of DMs with people asking a similar question. If Bitcoin has this great inflation hedge narrative, why did it go down on a day that

inflation seemed to be so far up? My answer was always the same. The inflation hedge narrative wasn't about Bitcoin responding on a day-to-day time, line to changes in the official inflation numbers. It was about setting a context that over a process of a full 12 months created the opening for institutional buyers to explore Bitcoin more deeply. Another way to put it is that the price of Bitcoin did respond to the inflation hedge narrative. It's what drove it into Sailor's Treasury and then to break $20,000 after three years of waiting and then finally all the way up to its cycle highs. In other words, narratives aren't about day-to-day

movements. They're about broad patterns. Which is why it's worth paying attention to another thread from Chow this morning. Quote, I'm seeing a growing tapering narrative in the macro world. This is by far the most important thing you should pay attention to as far as the bull market is concerned. More important than any chart, metrics, or narratives you're looking at. Let's not pretend otherwise. Virtually every coin, company, and product in crypto is at least indirectly fueled by central bank-induced speculative fervor. So long as this is the case, we are highly vulnerable to central bankers' decisions. I'm going to explore more on what that means later this week. However, so as not to leave you on some big ominous notes, I promised yesterday that I would

ask around to a few folks who are deep in institutions to see what the actual story was from inside their conversations. Were these institutions freaking out? Were they panic selling? Or was it something different? What I heard was a distinct lack of stress. I heard that in general, most of the investors that had come into Bitcoin had come in with a very long-term view and so had expected volatility along the way. I heard that some who had accumulated at higher levels did some tax loss harvesting and re-entered at a lower cost basis. And just for a reference point, one firm I talked to said buying was 150% of selling. So perhaps these institutions really do have stronger hands than they're currently being given credit for. Whatever the case, I hope it's clear how important it is to understand not just

narratives, but also market structure when we're examining Bitcoin and crypto moves as a whole. I hope the show has been useful to you and helped you think about things a little. bit differently. And if there's more deeper that we need to get into on it, please let me know. As always, guys, I appreciate you listening. And until tomorrow, be safe and take care of each other. Peace. We're witnessing the greatest paradigm shift in finance in modern history. Join thousands of newsmakers and influencers talking the future of money at Consensus by CoinDesk. A live virtual experience of leaders, change makers, virtual reality meetups, keynotes from Ray Dalio, Gary Vaynerchuk, and much more. Get an up-close look at the boom in crypto, the surge and

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