When markets fell across the board in early March due to the Covid-19 pandemic, bitcoin tumbled alongside them. While leading up to March, bitcoin’s market cap of around $170 billion was still tiny when compared to equities, treasuries or gold, the sheer magnitude of a 50% drop in two days compared to other assets certainly raised some eyebrows, writes CoinShares analyst Christopher Bendiksen.
However, its subsequent rebound to pre-Covid-19 levels without intervention or external stimulus has also unsurprisingly garnered attention in the investment community.
Understanding how and why these movements occurred are important questions to answer; not least because knowing the mechanisms that were at play could help investors get a better understanding of which metrics are useful in gauging ongoing volatility risk.
Understanding also helps us appreciate just how resilient bitcoin can be.
So, what happened and why?
In short, we believe the tumble was ignited by fear spreading from other markets. It then became particularly severe due to bitcoin’s unique market structure. The overall usage of leverage in bitcoin spot and derivatives markets is generally large, but in the time leading into March 12 & 13, leverage levels were abnormally high, making them extra vulnerable to shocks.
When spot markets started coming down alongside global financial markets, this triggered a particularly sharp liquidation cascade. It started on leveraged spot and derivatives exchanges. Then, due to the speed and size of the price drop, a minimum of $500 million (likely as much as $1 billion or more) of bitcoin-collateralized loans were auto-liquidated, adding further selling pressure to spot exchanges over a very short time.
Interestingly, even after sustaining a drop of that magnitude, bitcoin not only found a natural bottom, it vigorously rebounded over the succeeding weeks and liquidity levels have normalized. Not only does that demonstrate that what we observed was a market dislocation caused by exogenous shocks, not a broad revaluation, but it also shows that bitcoin markets are highly resilient and self-correcting, even in the complete absence of external intervention.
In its aftermath, bitcoin’s market structure has not materially changed and there is little reason to expect that it will over the near- to mid-term. In other words, it is possible that, given the right set of circumstances, volatility events like the one we saw in March could happen again.
Financial markets were on shaky ground in early March
Coming into the second week of March, global equity markets had already come approximately 20% off of their February highs due to Covid fears. Traditional safe-haven assets such as gold and treasuries were outperforming. Certain other assets, such as oil, fared particularly poorly as global air travel came to an almost complete halt.
Read more:How bitcoin beat Covid