Quick Update: Volatility in the Markets Yesterday
What happened? And does it change the broader market structure?
Hello readers,
Yesterday was a pretty wild day in the markets. As such, I wanted to check in with a quick update. If you’re new to crypto, it probably felt pretty scary. We woke up to high volatility as Bitcoin had plummeted about 15% in a matter of hours.
Bitcoin is the largest cryptoasset and tends to lead while the rest of the cryptoasset economy follows. Many altcoins were down 25% over the same time period. So what happened?
On Monday afternoon, Twitter started to buzz as the President of El Salvador began announcing purchases of Bitcoin by the Government in anticipation of “Bitcoin Day.”
If you aren’t aware, El Salvador made Bitcoin legal tender yesterday.
We started to see the price running up Monday afternoon and into the evening as a result of the hype around this. As such, trader sentiment flipped positive. When sentiment flips positive, traders will put on leverage and try to ride the momentum, increasing their returns.
This was all looking good until some large holders decided to sell a bunch of spot Bitcoin into the brief rally. That immediately knocked the price down and caught these margin traders offside. We can visualize that below:
The cascade of liquidations drove the price down until we bottomed at around $46k. Again, this is why you should always avoid using leverage in crypto.
As a result, we saw over $4b of futures open interest (total futures contracts) closed out:
In the report that went out on Monday, I had noted that leverage and futures open interest were actually relatively low in comparison to what we saw last spring when we had a 50% price correction. While that was the case, there was still enough margin in the system to kick off a bout of volatility.
However, nothing has changed structurally from what we noted on Monday. Typically, when we get a drop in price, we can see a spike in coins sent into exchanges. This would indicate spot selling. This was not the case yesterday. In fact, supply on exchanges continues to drop:
This is a positive indicator and further points to the volatility yesterday coming from leveraged liquidations rather than selling from long-term holders. In fact, I would argue this positions the market back to an even healthier state as we move forward.
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A quick note on volatility:
My sense is that most traditional investors view volatility as inherently bad and risky. The word itself tends to evoke an emotional response. However, as someone who has deeply studied these markets, I now view volatility as a good thing. We simply need to re-frame how we think about volatility.
For example, would you rather own something that has a compound annual growth rate of 113% per year since its inception? Or would you rather own the S&P 500 which is less volatile but will produce an average return closer to 8%? Maybe you want a little of both, but you get the point.
For an investor to be at peace with volatility, he/she must have conviction about the asset and a long-term view. Your time preference must be low. If you’ve invested money that you’ll need in 2 months, well, volatility could be very bad for you. If you have a 5+ year time horizon, volatility is actually good.
Furthermore, I would argue that volatility in Bitcoin is a feature of the asset, not a bug. Bitcoin has a supply that is completely fixed and inelastic to demand. Therefore the price is the release valve when demand picks up or we get a supply shock (after each halving).
We also need to consider that Bitcoin is a 100% free and open market. There is no central bank or government at the helm here. Therefore, we get this incredibly pure and natural price discovery. And guess what? It’s volatile.
However, Bitcoin is not inherently volatile. Bitcoin is just a neutral technology. People are volatile. Fear & greed drive human behavior. And when we layer on the fact that crypto markets are primarily inhabited by younger, less experienced market participants, we can understand why we see big swings in the price on a consistent basis.
Finally, when I look back in history, I have a very difficult time finding assets in nascent industries that did not experience high volatility in the early growth years. It tends to come with the territory.
As we unpack the dynamics at play here, we can begin to view volatility for what it is. And when we do that we can stay off of the rollercoaster and watch the show from a distance.
That’s all for today.
Thanks for reading and for your support. We’ll be shifting more toward high-level frameworks for how to analyze and evaluate various cryptoassets moving forward.
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And stay curious my friends.
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Individuals have unique circumstances, goals, and risk tolerances, so you should consult a certified investment professional and/or do your own diligence before making investment decisions. Certified professionals can provide individualized investment advice tailored to your unique situation. This research report is for general investment information only, is not individualized, and as such does not constitute investment advice.