On Sunday, August 2, the price of Bitcoin (BTC) dropped by 12% in just 5 minutes. During the same period, Ether (ETH) dropped by 21% and similar losses were observed with many other altcoins.
In retrospect, the general consensus on the cause was an unknown entity that raised roughly $ 1 billion on the open market in a time of low volume and liquidity.
At first thought one would assume that selling such an enormous amount in an illiquid market would be it for the seller, but given the size of the move, we do not think the seller was unaware of what would happen.
In fact, it is entirely possible that the orchestral movement was 100% intentional. Here’s how the crypto market was pushed into a sharp correction with one big sale.
How the flash crash may have been intended
This was a well-transparent move in which the buyer was busy buying coins in the spot market as the price got closer and apparently technical resistance.
After the investor builds a position, they then place a large market order to take down all the offers on 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 stopped buying above the resistance level. At the same time, a short squeeze was caused by traders who were short of this resistance level.
The investor who submitted the large market order has now enjoyed the price appreciation of the coins purchased before the breakout, following the boosted momentum.
After a while, these traders decide that it is time to call up the register. Thus, he quietly builds a short futures position on different exchanges with different accounts to be as stealth as possible.
With the help of 30x to 50x levy, the investor is able to maintain the position even if the price of the underlying capital goes up by 2% or 3%.
Once it has accumulated a large enough short futures position, it then sells the previously purchased stash of BTC at market rate when the market again exhibits low liquidity.
This removes all bids in the order book, resulting in a price crash that ignites as he had built for a short position with futures. The result is, a nice win is locked away from the short position.
A few examples of how it was done:
Let’s say BTC trades at $ 9.9K and the key resistance is at $ 10K.
A trader builds a stealthy position of 100 BTC with about $ 1 million in cash at an average price of $ 9.9K. He then placed a market order to buy 100 BTC at a time when the market’s liquidity was low and this immediately pushed the price to $ 10.4K.
This means that its average position is 200 BTC at $ 10,150. The move above the obvious resistance price forces other traders to buy above $ 10K, and also catalyzes a short squeeze that forces short traders to cover their position by buying back the underlying. This results in even more upward pressure on the price of the underlying and phase 1 of the trading plan is complete.
Now BTC is sitting at $ 11.8K and the trader manipulating the market is starting to build a short futures position with 30x to 50x charge. For simplicity, let’s consider 50x tax, meaning for $ 1 invested, $ 50 of the underlying capital is obtained.
The trader rebuilds a stealth short position in futures markets across multiple exchanges with multiple accounts. While he has been used 50x, to cover his long position of 200 BTC of $ 2.36 million, he has to sell shorts for only 200BTC / 50 = 4 BTC.
He would then use some of the proceeds of his first purchase to cover the margin of futures contracts of 4 BTC.
Of course, he can also sell more futures to further increase the movement and his upcoming bad profit as well.
The final move
The trader completes his fun strategy by selling the 200 BTC he initially bought all at the same time on the market when the liquidity of the market is low.
This results in crashing of the BTC price from $ 11.8K to $ 10.1K. His price for long position was $ 10,150, so while taking a slight $ 10K loss on his starting position, he benefits significantly from the short selling futures. The result is a net profit of $ 330K as 16.5% of the initial $ 2 million invested and all this was done with minimal risk.
The takeaway
Of course, this is an all-too-simplified example of how big players manipulate the market and profit from weekends when liquidity and trading volumes are lower.
This type of installation requires a significant amount of upfront capital and decent trading infrastructure to run seamlessly. But, given the liquidity and volatility of the crypto-currency versus traditional markets, just $ 10 million of capital could lead to decent returns with minimal risk.
This is at least possible until regulators introduce it.
There are ways to make this maneuver with even more charge. By using futures to take the initial long position that requires a fraction of its nominal value to trade, and buying call options instead of selling futures to take even more advantage of the provoked decline due to the convexity of the options.
However, such a practice requires specific market conditions (i.e. a well-considered instrument with price close to a major technical point) and an easy-to-manipulate instrument (that is, an instrument for which derivatives exist). Therefore, this play can not be performed completely.
In principle, the whole maneuver is market manipulation and it is completely illegal in traditional markets. In the wild west of crypto-land, however, unscrupulous traders may for the time being still trade with little concern.
The hope is that as cryptocurrencies mature, these types of games for price manipulation will disappear.
As the market grows, the greater amount needed to combat these types of actions, and the increased risk that an even greater player may face the one who initiates the move may limit manipulation.
The views expressed here and there are those of the author only and do not necessarily reflect the views of Cointelegraph. Every move of investing and trading involves risk. You have to do your own research when making a decision.
