Market Meltdown to Stress Testing the Cryptocurrency Parallel Financial Universe

(March 14th 2020 by TokenInsight Research)

We have observed that due to the limited market liquidity and a sudden price downside movement, long squeezes occurred in the market, when the market tanks, liquidating several at-risk leveraged long positions. Due to the liquidation and the worsening of overall market conditions, the market felt an impulsive move to the downside was imminent, in the meantime market participants pulling off some of the market buy orders, selling pressure built up coupled with liquidation effect drying up the buy-side liquidity significantly. The market quickly turns to extreme fear and market-wide sell-off started.

The sell-off has revealed significant issues in the industry, the market is still not well-positioned to provide sufficient liquidity in this extreme market condition, the performance of many exchanges deteriorated further dries up the market liquidity, triggered a market-wide panic, and caused prices to fall sharply.

Overview

Bitcoin plummeted as the cryptocurrency market experienced a market-wide panic alongside a significant liquidity crunch on the buy-side order book, back down to $5K from $7K range, the market continued its strong downside movement and briefly touched sub $4K and rebounded sharply to $6K, wiped off more than $90 billion in value at the lowest market point. Over the past week, we have seen both the equity and cryptocurrency market tumbles sharply. At the time of writing this analysis piece, Bitcoin is hovering around the $5K range.

The sell-off has revealed significant issues in the industry, the market is still not well-positioned to provide sufficient liquidity in this extreme market condition, the performance of many exchanges deteriorated further dries up the market liquidity, triggered a market-wide panic, and caused prices to fall sharply.

We believe the market sell-offs are mainly due to,

· Market liquidity crunch

· Market-wide panic

· Exchange system overloads and blockchain network congestions

· Thin market condition

We have observed that due to the limited market liquidity and a sudden price downside movement, long squeezes occurred in the market, when the market tanks, liquidating several at-risk leveraged long positions. Due to the liquidation and the worsening of overall market conditions, the market felt an impulsive move to the downside was imminent, in the meantime market participants pulling off some of the market buy orders, selling pressure built up coupled with liquidation effect drying up the buy-side liquidity significantly. The market quickly turns to extreme fear and market-wide sell-off started.

Exchange Order Book Liquidity Analysis

We have leveraged in house market data to analyse the impact on liquidity during such impulsive moves. The following analysis does not provide a full picture of the exchange liquidity, it is to demonstrate the change in liquidity during the market sell-off only, and thus it does not appropriately reflect a full picture of the exchange liquidity.

According to the hourly order book liquidity data from Binance during March 12th 2020 (GMT+8), strong selling pressures started to build up rapidly when the market began its sell-off.

Figure 1: Binance- BTC/USDT pair hourly aggregate volume from the 10 best ask (sell) & bid (buy) orders on March 12th 2020, 12 PM-11 PM (GMT+8)

Its bitcoin market liquidity started to build up when the price just began to fall. However, since 6 PM (GMT+8) on March 12th, the selling pressure has developed rapidly and extended the buy & sell-side gap to reach more than 100K bitcoins in volume. As the market continues evolving, the gap gradually dropped from the 50K-60K range to the 20–30K range despite the sells continuing pressing the buys. When the market continued experiencing downside pressure, the aggregate volume of the 10 best ask (sell) orders increased rapidly, and the aggregate amount of bids (buy) orders changed a little.

Figure 2: Binance- BTC/USDT pair 5-minutes aggregate volume from the 10 best ask (sell) & bid (buy) orders on March 12th 2020, 7 PM-8 PM (GMT+8)

There was nearly a 100K bitcoin volume gap during the same period on Huobi, however, unlike the situation on Binance, buy-side orders on Huobi increased rapidly in the later stage. As OKEx’s data significantly differ with Huobi and Binance, we will not include the data in this analysis due to the statistical anomaly.

Figure 4: OKEx- BTC/USDT pair hourly aggregate volume from the 10 best ask (sell) & bid (buy) orders on March 12th 2020, 12 PM-11 PM (GMT+8)

Observing the data from the three top tier exchanges in the industry, we can conclude that when the market faces such extreme conditions, there are significant differences between the buy and sell-side liquidity on different exchanges.

Huobi’s data tell a slightly different story during the 7 PM — 8 PM window, with maximum 23K bitcoin order gap occurred at 7:05 PM — 7:10 PM, a completely opposite scenario compared to Binance.

Wash Trading Analysis

Based on the TokenInsight’s wash trading analysis model and price data from the BTC/USDT pair. We believe that there were no obvious wash trading activities during the market sell-off, reflecting true liquidity has been presented in the market.

Figure 7: Wash Trading Analysis (Source: TokenInsight)

Backend System Overloads

The exchange backend systems have also been put under the pressure during this extreme market condition. Some of the exchanges have faced system overloads due to inadequate backend risk control measures, reflecting the fragile nature of the industry’s infrastructure. Users face difficulties in terms of accessing the fiat OTC gateway in China and issues with withdrawal and deposits emerge. This is directly reflected in the strong market demands of the USDT/CNY market pair.

Figure 8: CNY/USDT OTC Price (March 13th 2020, 6:33 PM GMT+8)

The CNY/USDT OTC market has traded at a significant premium over the CNH/USD (Offshore CNY) pair and currently maintained its premium position at 7.45 (CNH/USD mid-price is at 7.02). The 5%+ premium could signify a strong market demand in USDT in the Chinese market as a channel to accumulate “cheap” bitcoin.

The cause of USDT premium can also be partially explained by the congestions on the Ethereum network.

Based on the statistics from Etherscan, Bloxy and Coin Metrics, Ethereum experienced a significant network transaction volume during the market downturn, turning into network congestions. The average gas price has shot up to at least 10x in the 24-hour market sell-off (March 12th- March 13th 2020). As the majority of Tether USDT has now been issued on the Ethereum network as an ERC20 token, this further drys up the USDT liquidity in the Chinese market side.

Figure 9: Gas Prices (Source: ETH Gas Station, Unit:Gwei)

When the market started to sell off initially, the market’s buy-side liquidity dried up very quickly due to long squeezes, coupled with network congestions on the Ethereum network which means the market participants were unable to provide natural buy-side liquidity by transferring USDT to the exchanges or respective

trading venues to build up the buy-side liquidity in the market.

Figure 10: ETH Median Fee USD, Per Block (Source: Coin Metrics Network Data Pro, Block-by-Block

in the last 24 hours (Source: Bloxy)
Figure 11: Top Ethereum tokens transfers

As USDT ERC20 transfer increased significantly and accounts for the majority of transactions on the Ethereum network, followed by DAI and USDC stablecoin. The median fee in USD per block for the Ethereum network trended up during the 24-hour market plunge. As network congestions continued, the ETH block reward included network transaction fees spiked significantly (Coin Metrics, 2020), indicating market participants spending a significantly higher amount of gas fees to speed up the transfer of USDT ERC20, hope to build up the liquidity book on exchanges.

We believe when the CNY/USDT premium returns to a more acceptable range, we could see the market returns to a better condition.

Figure 12: ETH Block Reward, Per Block (Source: Coin Metrics Network Data Pro, Block-by-Block)

The Market Sell-off Impacts on Cryptocurrency Mining

We believe the market sell-off does not have a major impact on the mining industry in general in a short term, as most of the miners do not make strategic decisions based on the very short term bitcoin price fluctuation. However, If the market downturn sustains longer than miners’ expectation, some of them will close shop and eventually cut losses. Based on the mining revenue comparison figures published on F2Pool.com, Antminer S9 has reached the end of its lifecycle, producing negative return based on $0.05/kWh, current network difficulty and current bitcoin price.

Some institutionalised miners leverage lending facilities to borrow fiat against their crypto assets to pay operation costs such as electricity. Some well-established miners also use structured financial products to hedge against these extreme market conditions.

As we can see on the figure, the bitcoin hash rate has consistently dropped right before the market sell-off and increased during the 24 hours market selloff window. The overall short term hash rate fluctuation can be considered as normal, as we can see in the 1-month bitcoin hash rate chart.

Figure 13: 1 Month Bitcoin Hashrate Chart (Source: Coinwarz)

Summary and Final Thoughts

The market carnage is a stress test for cryptocurrency industry, not only testing the industry’s infrastructure such as exchanges but also testing other businesses such as crypto lending facilities, mining industry etc. It is a stress testing exercise to understand how well the cryptocurrency industry can handle such extreme market events, preparing for a maturing cryptocurrency industry. The liquidity shortage, infrastructure overloads combined with market-wide panic shows that the cryptocurrency market is still maturing and still falls short of the requirements for the Bitcoin ETFs.

As the global market turmoil continues due to fear of recession and COVID-19 pandemic impact begins to emerge globally. We believe this time is different and potentially is much worse than the 2008 Global Financial Crisis. It could begin as a global economic crisis whereby the global economy experiences a sudden downturn due to a financial crisis, impacting every single aspect of our daily life.

We believe cryptocurrency like any other asset class, is in an irrational stage. In light of market-wide panic, the financial model and structured diversified strategies might not be effective. We believe the market requires a period to shake off the irrationality and return to a more rational state. When the market panics, liquidity dries up creating an eventful market condition, cascading like a snowball effect leads to a strong downside movement which drives the market panic further. Warren Buffett once said that “Be fearful when others are greedy and greedy when others are fearful”.

About TokenInsight

Founded in 2017, TokenInsight is a Leading Data & Tech Driven Blockchain Financial Institution. TokenInsight pioneered a complete blockchain industry classification system, covering more than 1,600 projects, releasing more than 300 rating reports, and conducting in-depth studies into 10 major industries.

TokenInsight’s data, ratings, and research reports have access to more than 70 data platforms worldwide, including Messari, Delta, Binance Info, AICoin, Huobi Info, etc., with a monthly PV of over 30 million. TokenInsight has officially joined the Data Accountability and Transparency Alliance (DATA), initiated by cryptocurrency ranking site CoinMarketCap.

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TokenInsight

TokenInsight

Leading Data&Tech-driven Blockchain Financial Institution.

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