Sunday August 2 the price of Bitcoin (BTC) fell 12% in just 5 minutes. In the same time frame, Ether (ETH) fell 21% and similar losses were seen with many other altcoins.
In retrospect, the general consensus on the cause was an unknown entity that dumped approximately $ 1 billion on the open market during a time of low volume and liquidity.
At first glance, it could be assumed that selling such a large amount in an illiquid market would be to the detriment of the seller, but given the magnitude of the move, we don’t think the seller is unaware of what would happen.
In fact, it is quite possible that the orchestrated movement was 100% intentional. This is how the cryptocurrency market suffered a strong correction with a big sell-off.
How the flash crash or sudden collapse could have been intentional
This was a well thought out move which involved the buyer starting to buy coins on the spot market when the price approached an obvious key technical resistance.
Once the investor built a position, they placed a large market order to remove all offers in the order book and push the price sharply below a key resistance level.
This maneuver triggered a significant number of buy orders from other investors who had stops to buy above the resistance level. At the same time, there was a bearish contraction due to traders who were short from this resistance level.
The investor who placed the large market order now enjoys the appreciation of the price of the purchased currencies before the breakout, after the momentum ignited.
After a while, this trader decides that it is time to mark the record. Therefore, silently build a short futures position on various exchanges using different accounts to be as stealthy as possible.
With 30x to 50x leverage, the investor can hold the position even if the price of the underlying asset rises by 2% or 3%.
Once you have built up a large enough short futures position, you then sell the previously purchased stash of BTC at the market rate when the market shows low liquidity again.
By doing this, all bids in the order book are removed, resulting in a price drop that ignites to the time you had previously built a short futures position. The result is that a good profit is secured from the short position.
Some examples of how it is done:
Let’s say BTC is trading at $ 9.9 thousand and the key resistance is at $ 10 thousand.
A trader builds a stealth position of 100 BTC with approximately $ 1 million in cash at an average price of $ 9.9 thousand. Then you place a market order to buy 100 BTC at a time when market liquidity is low and this instantly pushed the price to $ 10.4 thousand.
This means that your average position is 200 BTC at $ 10,150. Movement above the obvious resistance price causes other traders to buy above $ 10K and also catalyzes a bearish contraction that forces short traders to hedge their position by buying the underlying again. This results in even greater pressure on the price of the underlying and phase 1 of the trader’s plan is complete.
Now BTC is at USD 11.8 thousand and the trader who manipulates the market begins to build a short position in futures with a leverage of 30x to 50x. For simplicity, let’s consider 50x leverage, which means that for $ 1 invested, you get $ 50 of the underlying asset.
The trader rebuilds a stealth short position in the futures markets on various exchanges using multiple accounts. Since you have 50x leverage, to hedge your $ 2.36 million worth of 200 BTC long position, you need to sell short for just 200 BTC / 50 = 4 BTC.
You would then use some of the proceeds from your initial purchase to cover the margin on futures contracts worth 4 BTC.
Of course, you can also sell more futures to further magnify the move and your next ill-gotten gains as well.
The final move
EThe trader completes his ingenious strategy by selling the 200 BTC he initially bought in the market at once when market liquidity is low.
This results in the BTC price drop from USD 11.8 thousand to USD 10.1 thousand. The price of your long position was $ 10,150, so while you suffer a small loss of $ 10,000 on your initial position, you benefit significantly from futures sold short. The result is a net profit of USD 330 thousand or 16.5% of the USD 2 million invested initially and all this was done with minimal risk.
The result
Obviously this is an oversimplified example of how big players manipulate the market and take advantage of weekends when liquidity and trading volumes are lower.
This type of setup requires a significant amount of startup capital and decent business infrastructure to run smoothly.. But, given the liquidity and volatility of the cryptocurrency market versus traditional markets, only $ 10 million of equity could generate decent returns with minimal risk.
This is at least feasible until regulators intervene.
There are ways to carry out this maneuver with even more influence. By using futures to take the initial long position that requires a fraction of its notional value to trade, and buying put options instead of selling futures to further benefit from the downward movement caused by convexity of the options.
However, Such a practice requires specific market conditions (that is, a well-regarded instrument priced close to a key technical point) and an instrument that is easy to manipulate (that is, an instrument for which derivatives exist). Therefore, this work cannot be done all the time.
Basically the whole maneuver is market manipulation and is completely illegal in traditional markets. However, in the wild west of cryptocurrency land, unscrupulous traders can still act with little concern for now.
The hope is that as the crypto markets mature, these kinds of price manipulation games will go away.
As the market grows, the greater amount of cash required to perpetuate these types of acts and the greater risk that an even bigger player may counter the one who started the move may deter manipulation.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and commercial movement involves a risk. You should do your own research when making a decision.
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