If you're reading this, chances are it's because the crypto market is crashing. It's crashing. Now, even though there are many reasons why the crypto market crashes, they tend to fall into the same old categories. That's why today we're going to look at the reasons why the crypto market is tanking and whether it's a dip to buy or the beginning of lower lows. My name is Guy and this is something you literally cannot afford to miss. I'll start by saying that nothing here is financial advice. It's just educational content intended to inform you about why the crypto market crashes. Please contact a financial adviser if you need help deciding what to do with your cash or crypto.
Okay, with that said, crypto market crashes tend to be caused by a bearish macro catalyst, a bearish crypto catalyst, or some painful combination of both. Before we dive into these catalysts though, it's important to talk about the most important catalyst of all, and that is leverage. You see, in crypto, it's very common to trade with leverage. And this basically means trading with borrowed money. So, for example, if you trade with 5x leverage and provide $100 as margin, you can trade as if you had $500. Now, this significantly increases your potential returns, but also your potential losses.
For instance, imagine you're trading a crypto with 5x leverage and going long, which means betting that its price will go up. If that crypto falls by 20%, you will be liquidated. This means the $100 you put in as your margin gets automatically sold. And this is called a long liquidation. On the flip side, imagine you're trading a crypto with 5x leverage and going short, which means you're betting its price will go down. If that crypto goes up by 20%, you will again be liquidated. This means the $100 you put in as your margin is basically used to buy the crypto you are betting on. And this is called a short squeeze.
Now, you need to understand this because most of crypto's short-term price action is driven by either long liquidations or short squeezes. Suppose there's some bearish macro or crypto catalyst like the sudden escalation of a war, for example. Now, the actual impact this has on crypto could be objectively minimal, but it's enough to trigger a massive wave of long liquidations due to all the leverage in crypto. During these flash crashes, it's common to see hundreds of millions, sometimes billions of dollars of long liquidations happen in the span of a few days, sometimes even a few hours.
As we just learned, this translates to hundreds of millions, sometimes billions of dollars of crypto being automatically sold in a very short period of time, which causes crypto prices to fall sharply. And not only that, if this price drop happens to cause BTC, ETH, or some other major cryptocurrency to fall below an important price level, like say $100,000 or $4,000, then this tends to trigger more long liquidations and also panic selling from other crypto traders and investors. In turn, this can trigger even more long liquidations, pushing crypto prices lower than you'd expect in the short term.
Now, the good news is that these so-called cascading liquidations tend to be short-lived and usually end after a couple of days at most. After that, it's fairly common for crypto to experience a V-shaped recovery as traders and investors realize that prices fell much lower than they should and start buying the dip. And as a fun fact, this V-shaped recovery is often caused by short squeezes from traders who started shorting at the lows.
Now, it's extremely important to note that the price action after a long liquidation ultimately depends on the catalyst that caused the long liquidation in the first place. If the catalyst was something severe that could continue to create exogenous shocks, then the dip may not get bought as aggressively and prices might have a harder time recovering.