Liquidity Crisis: A Post Mortem of Yesterday's Events

SEP 08, 2021 • 4 Min Read

Key Takeaways

  • $4B and $3.6B of BTC and ETH open interest were respectively wiped out yesterday. BTC’s open interest ran up from its local low of $10B in Jul. 2021 to over $18B a few days ago. An 8B rise in OI, and half of that was wiped out yesterday. If you look at the absolute open interest levels, it’s quite clear we were growing too fast. But looking at open interest growth relative to market cap helps us discern if leveraged traders were getting ahead of themselves and piling into positions before BTC had the chance to move.

  • Liquidations are a great way to sell BTC at an exorbitant premium or buy it for far below its fair value. Yesterday was a case of longs get liquidated, implying whales buying cheap BTC from leverage traders who got in over their heads. Often times, larger players engineer liquidations by forcing price down to a certain level and allowing to leveraged positions to cascade. The reason for doing so, as mentioned above, is the ability to generate a large amount of liquidity to purchase BTC below fair value.

  • More often than not, events like yesterday are completely explained by a sudden collapse in liquidity. Looking at the bid-ask spread for a $5M BTC futures buy, the spread was never above half a percent, until suddenly it jumps up to 4% on Deribit and around 1.5-2% on other exchanges for a brief period yesterday.

  • Realized volatility is now on the rise and it’s very possible the market goes through a period of ranged price action. Short-term vols would also rise if the market posed a heroic comeback to highs seen earlier this month. Either way, it’s starting to look like we could be in for a period of high volatility — so prepare accordingly.

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