Thread by @OnrampAcademy

1/ Last night bitcoin plummeted 18.6% in a matter of hours and most of the other cryptoassets got hit harder than that... What happened?

Time for a thread.

2/ To understand what happened we must first dive into futures open interest.

Futures open interest is the total number of outstanding future contracts that have not been settled for an asset.

3/ ​​In early October the SEC approved a BTC futures ETF, which led to a large increase in the bitcoin futures open interest over the last two months.

coindesk.com/markets/2021/1…

4/ Here is the thing about open interest... because future contracts are often purchased using leverage, it also serves as a proxy for measuring leverage. So, as the ETF came onto the market, leverage in the system had been building.

5/ Sudden price movements can cause a trader to fall below margin requirements, resulting in a forced liquidation. When longs are liquidated, they may be forced to sell, putting downward pressure on price.

6/ Because of this, liquidations tend to be self-reinforcing - liquidations trigger more liquidations. This can lead to liquidation cascades, which can sometimes cause large, sudden downward movements in price.

7/ This is exactly what happened starting around 8:20pm PT on December 3rd. Liquidations accelerated as we moved down through $50k price for bitcoin, which resulted in $4.4 billion of futures open interest closed out in less than 3 hours.

8/ That was 21% of all futures contracts that were open at the time. This is what a leverage flush out looks like.

9/ However, there is good news.

While liquidation cascades have dramatic effects on price, they don’t change the underlying fundamentals.

10/ Although painful in the short-term, leverage flushes are typically healthy over the long-term.

If the system gets over-leveraged, flash crashes can help flush out some of the riskier contracts and reset to healthier levels.

11/ This creates a more solid foundation for building towards the next leg up. Despite the short-term price drop, the ecosystem should continue to grow over the long run as crypto gets adopted by more and more people around the world.