Contagion Warning From Crypto Markets Could Be A Buy Signal

One of the reasons the 2020 market crash was so severe and sudden was that overextended investors sold out of positions to liquidate funds, which drove prices down further, and created a need for further selling. That vicious circle hasn’t occurred (yet) in the market sell-off of 2022, which in relative terms looks more like a gradual realisation that the market is overcooked. Or is it?

Bitcoin Price Crash

While many investors have focused on the remorseless but gradual slide in the currency and equity markets, the crypto markets have performed their own sideshow. One which did involve a liquidity crisis and resulted in Bitcoin and Ether losing 25.9% and 30.62% in value in the space of just four days running up to Thursday 12^th May. If you take a reading from Thursday 5^th to Thursday 12^th May, the price crash in both coins is 36.26% and 41.73%.

Time to Buy the Bitcoin Dips?

When an asset loses almost half of its value in the space of a week, then there is usually something going on behind the scenes. Reports from the crypto sector point to the recent selling activity in the big coins being driven by factors unrelated to their individual prospects, which does open the door to this being an opportunity to buy into the dip.

Ether – Daily Price Chart –2021 – May 2022 – Liquidity driven sell-off

Source: IG

The price crash in Bitcoin and Ether appears driven by events relating to TerraUSD (UST) and Luna. That stablecoin which isn’t backed up by fiat currency, came under enough selling pressure last week to leave investors holding almost worthless positions. It’s estimated that holders of UST and Luna lost $42bn in the space of a week, with the price of Luna crashing from $85 to four cents.

Bitcoin – Daily Price Chart –2021 – May 2022 – Liquidity driven sell-off

Source: IG

The complex framework which was supposed to result in UST being stable was just too clever for its own good or too clever to instil confidence. At the same time, the $3bn of Bitcoin held by the Luna Foundation Guard and supposed to act as collateral proved to be too small to prop up TerraUSD.

All fingers point to the selling of the $3bn BTC position held by the Luna Foundation Guard as the catalyst for last week’s sell-off. Contrarian investors can now approach this as a test that Bitcoin has passed and will note that the selling pressure is all done, for now at least. With Bitcoin trading at price levels not seen for 18 months, the market looks set to rebound. Sell the rumour, buy the fact.

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About the author: Justin Freeman

Justin is an active trader with more than 20-years’ industry experience of working for big banks and hedge funds. He has an inside knowledge of how the financial markets work, thanks to roles including trader on a $750m Event-Arbitrage desk and CRO and COO of hedge funds running a variety of strategies. From stat-arb and trend-following CTA to fixed-income relative value. Firm’s he has worked at include big banks like Citi, and prominent hedge funds including D. E. Shaw and Millennium Capital Management.

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