Markets Weekly: Bitcoin's New Year Starts With a Crash

Bitcoin's price crashed over the New Year weekend, losing $51 over two days. According to the CoinDesk Bitcoin Price Index, the currency opened on Saturday at $314.59 and closed the following day at $263.63.

The plunging price got market watchers chattering as Sunday drew to a close. Unsurprisingly, a contingent of bitcoin watchers put a positive spin on the price crash, viewing it as a buying opportunity, albeit with a note of alarm.

Even among bitcoin bulls, Tim Draper's call for Russian ruble-holders to switch from their rapidly devaluing sovereign currency was particularly ill-timed:

Another flash crash?

So, what triggered the crash? One theory is that savvy short-sellers timed their move for the thinly traded holiday season, betting on setting off a cascading margin-call as they nudged the price down.

As the price moved against traders with leveraged long positions – perhaps banking on a rise in the bitcoin price, which was trading at 2014 lows in December – a rising number of leveraged positions were closed, with coins liquidated at the prevailing price.

In other words, it's another 'flash crash' triggered by margin calls of the sort the market saw in August. Back then, a series of big intra-day declines drove the price from the $600 level to under $500.

That's the theory offered by Alistair Milne, the portfolio manager at the Monaco-based Altana Digital Currency Fund. Milne says he saw sell orders for hundreds of coins with no limit price appear on the order book of Bitfinex over the weekend, which he took as a sign that leveraged positions were being automatically closed by the exchange.

A sharp drop in leveraged long positions lends support to Milne's theory. US dollar swaps on Bitfinex fell by $2.48m or 12% over the weekend, as the price plummeted. Traders on the platform use dollar swaps if they want to bet on margin that bitcoin's price will rise.

Still, the closed leveraged long positions of $2.48m on Bitfinex is small when compared with a total of $82.7m-worth of trades in the BTC/USD markets across all exchanges tracked by Bitcoinity.

Open short swaps have also risen steeply against long swaps. Over the last 24 hours, the portion of short swaps has risen 25 points, from 63% to 88%. In other words Bitfinex traders are continuing to bet that the price of bitcoin will fall.

Money never sleeps, except at Christmas

The Christmas and New Year holidays could have played a critical role in this short-sellers haven. Exchanges are thinly traded over the holiday period, with a fall of 24% in the final week of December compared to a week earlier, for example.

Then there are the practicalities of modern banking. With banks closed over the holidays, traders could be caught without dry powder in their cryptocurrency trading accounts, unable to top up fiat funds when they need to. It all adds up to optimum conditions for short-sellers wishing to trigger margin calls.

Milne said:

"If you boil it all down, the price of bitcoin is firmly in the hands of the speculators. It looks to me like experienced traders with resources are exploiting inexperienced enthusiasts who should not be using leverage."

Some traders think the price has further to fall. Arthur Hayes of BitMEX says more pronouncements of bitcoin's failure as an asset class – of the sort found on Bitcoin Obituaries, for example – need to hit the market before a bottom is found.

"Not enough capitulation yet. Need a couple more media outlets saying, 'I told you so' about bitcoin being a bad investment," he said.

Gavin Smith at derivatives provider First Global Credit advises a similar wait and see approach, noting that the price could fall further before hitting a bottom.

The silver lining for bitcoin bulls now might be an opportunity to enter the market at lows that haven't been seen since November 2013, before the cryptocurrency's historic bull-run.

Milne, for one, says he's hearing from investors who are looking to load up on coins at these prices for the long term.

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