The largest liquidation event in crypto history took place on Friday, with more than $19 billion in positions liquidated in just 24 hours. coin glass. In the days since then, industry experts have been conducting postmortems on the disruption, highlighting rising leverage as a potential risk to the long-term health of the crypto market.
The growing popularity of HyperLiquid, a decentralized exchange specializing in perpetual futures trading, has made leverage in crypto more accessible than ever, leading competing exchanges to compete for leverage offerings. Some experts believe this is creating systemic risk, and asset management firm Bitwise is even considering changing its strategy as a result.
Leverage allows traders to bet using borrowed funds, putting them at risk of being forced into liquidation if things go wrong. Leverage is often combined with perpetual futures trading, which allows traders to speculate on the direction of an asset (referred to as “long” or “short”) using derivative contracts with no expiration date.
The combination of these trading strategies creates tremendous risk, which is amplified and exposed by big moves like Friday’s. Traditional markets impose limits and ratings on users seeking to access the highest levels of leverage.
Similar systems have been implemented on centralized exchanges, such as Binance, which requires users to pass a risk quiz in order to trade with leverage. However, decentralized exchanges superfluidity has grown rapidly this year, offering up to 40x leverage without requiring customer disclosure or quizzes. This is part of the selling point.
“What we’re seeing in the PERP market in particular is that leverage is a point of competition with these exchanges. In that sense, margin competition is creating systematic risk,” said Aryan Sheikalyan, head of research at venture capital firm CMT Digital. decryption. “As a result of this underlying competition, they are competing by lowering potentially correlated collateral ratios and cross-margin assets, as well as raising liquidation thresholds when it is too late.”
This competition can also be seen in the recent emergence of rival decentralized exchanges. asteroffers an amazing leverage of up to 1,001x on Bitcoin.
As a result, James Butterfill, head of research at CoinShares, said: decryption that derivative trading volume, It has more than doubled in size over the past year due to its ability to leverage leverage. Also, compared to spot trading, derivatives account for 73.7% of the trading volume on centralized exchanges, he said.
Gordon Grant, head of derivatives at Bitwise, said: decryption This is not representative of a growing risk appetite among crypto traders, as they have long been considered to be risk-seeking traders. Rather, he said, riskier trading strategies are now more accessible and easier to understand than ever before.
“Why aren’t there more retail users using options as leverage in cryptocurrencies, like in the stock world?” Grant said. “The answer is this: With cryptocurrencies, options are not that easy to access. If you are a North American investor, you may have a hard time even accessing exchanges like Deribit or OKX.”
Aster’s 1,001x Bitcoin Leverage service, on the other hand, simply requires you to connect your wallet to an exchange and place your bet.
This ease of access was further exacerbated by a series of short-term factors on Friday, resulting in a series of liquidations.
Grant believes leverage has increased again in the last week as spot market prices hover near all-time highs, which he says always leads to higher risk appetite. Moreover, Bitcoin lasted for several months extremely low volatility Then a massive flash crash occurred, which may have caught investors off guard.
“[These levels of leverage]create the possibility of cascading dynamics, where people take large leverages that may seem rational to them personally,” said GSR researcher Carlos Guzman. decryption. “If one person gets liquidated in isolation, that’s fine. There might be enough liquidity in the market to make up for it, so it’s not the worst thing to happen. But if one liquidation leads to another liquidation, which leads to another liquidation, then you’re absorbing all the liquidity in the market.”
Guzmán explained on Friday that the market had “exceeded” its capacity, effectively depleting available liquidity and sending the market into a state of “free fall.”
Bitwise is currently discussing whether it would be best to allocate 20% of its portfolio in cash to scoop up discounted assets during a future leverage cascade, Grant said. decryption. Following Friday’s events, the asset management firm has received questions from clients about whether double-digit declines in Bitcoin will become the new norm.
Jasper De Maere, OTC desk strategist at Wintermute, said: decryption This market trend may pose a greater risk to altcoins than Bitcoin, as perp market volume accounts for a more significant portion of market capitalization.
“Leverage tends to drive price discovery[in small-cap altcoins]because purp flows often outweigh spot activity and when positioning accumulates, even small shocks can cause large liquidations or sharp drawdowns,” Demere explained.
Ultimately, CoinShares’ Butterfill believes that the structural risks are not as great as those seen in traditional stock markets, and that they will fade over time.
“It is true that market panic creates liquidity cascades that exacerbate volatility,” Butterfill concluded. “However, this situation will likely subside as the market matures and the ratio of shorts to longs becomes more balanced.”
