The rapid sell-off in Bitcoin last week is a good example of how exogenous market factors can trigger endogenous market structure factors leading to a cascading sell-off.
This phenomenon is an important part of markets and (IMO) underappreciated.
This phenomenon is an important part of markets and (IMO) underappreciated.
In the case of Bitcoin, Phase 1 of the sell of was that there was a large hashrate drop which triggered a wave of selling.
However, that also forced a lot of overlevered players to cover their levered long positions (or they got liquidated), causing a second leg down.
However, that also forced a lot of overlevered players to cover their levered long positions (or they got liquidated), causing a second leg down.
I think this is important because the common understanding of price movements is that they are reflective of investors saying "I have updated my beliefs about the future value of this asset and am buying/selling based on that."
This is definitely part of the picture.
In this case, the first leg down was probably reflective of investors updating their beliefs about bitcoin's value: a lot of hashrate is concentrated in one province in China and that poses a real risk.
In this case, the first leg down was probably reflective of investors updating their beliefs about bitcoin's value: a lot of hashrate is concentrated in one province in China and that poses a real risk.
However, the second leg of the price drop was a result of market structure.
If you are levered 10:1 and get margin called, you have to sell, regardless of your beliefs.
If you are levered 10:1 and get margin called, you have to sell, regardless of your beliefs.
It was not implying that investors further lowered the expectations of bitcoin's value, just that levered people got rekd.
This is probably more common in bitcoin because it's not really regulated and people use a stupid amount of leverage.
But, you can see the same sand pile effect in other markets.
taylorpearson.me/interestingtim…
But, you can see the same sand pile effect in other markets.
taylorpearson.me/interestingtim…
I think there is reasonable evidence that what happened in Q1 2020 had a similar dynamic where an exogenous event (global pandemic) triggered the first leg down.
Then, endogenous factors relating to market structure triggered the next leg down.
Then, endogenous factors relating to market structure triggered the next leg down.
I think this is important because it's not how you will hear price moves explained. They are almost always explained in terms of exogenous events: Covid or a blackout in China in these examples.
Having spent a lot more time around traders over the last few years, one of the big lessons for me has been that exogenous events are only part of the picture.
Equally important is the market structure including how the players are interlinked and levered to one another.
Equally important is the market structure including how the players are interlinked and levered to one another.
This gets back, of course, to ergodicity.
The investor does not get the returns of the market if they are forced to liquidate!
taylorpearson.me/ergodicity/
The investor does not get the returns of the market if they are forced to liquidate!
taylorpearson.me/ergodicity/
data via @coinmetrics newsletter: coinmetrics.substack.com/p/coin-metrics…
[Insert all appropriate caveats that one can never truly KNOW what caused any price movement and so the above is all reasoning based on incomplete data]
[Insert all appropriate caveats that one can never truly KNOW what caused any price movement and so the above is all reasoning based on incomplete data]
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