What We Can Learn from Bitcoin’s “Flash Crash”

After skyrocketing and then crashing back down last year, Bitcoin has had an excellent 2019. Starting the year at a price of about $3,800, it hit a high of over $11,800 in June, and had continued to trade between $9,000 and $10,000.

That was the case until this past Tuesday, when in little over an hour, Bitcoin dropped more than 10% to $8,478.71, and continued sliding from there. By the end of the day, it was down more than 14%, and as I’m writing this, the benchmark cryptocurrency is down over 20% for the week.

After such a good eight months for Bitcoin, this “flash crash” took many traders by surprise. So it’s no wonder that pages and pages of explanation have been written. Everything from technical anomalies and futures contracts to manipulation by shadowy organizations has been blamed.

But sometimes, the answer to a complex problem is actually quite simple, especially to us traders.

In this case, that answer is right in front of our eyes…

Yes, Virginia, Traders do Believe in Charts – Even in Bitcoin

Of course, many of these other factors did play a role. I’ll show you how in a second. But the original cause to this week’s Bitcoin “flash crash” is much simpler.

Take a look at this chart:

Since mid-July, BTC had been in a chart pattern known as a descending triangle. When the floor of that triangle was broken, sellers poured in, causing a waterfall declince for prices.

Once those support levels had been broken through, less experienced bitcoin traders started worrying. After all, Bitcoin’s fall last year is still in people’s memory.

Fearful, they started looking for any fundamental clues in the news as to whether Bitcoin would keep falling.

This, as I often say here in 10-Minute Millionaire, is the exactly wrong way to go about trading. Once you start looking for evidence only to support a trade you already want to make, you’re sure to find just that.

As always, this time, the market obliged. Traders looking for any reason to sell found exactly what they were looking for…

Lots of Possibilities and One Clear Reason…

First, the day before the crash, a new cryptocurrency futures exchange had launched. Called Bakkt, it is run by Intercontinental Exchange Inc. (ICE), the American company that runs the New York Stock Exchange and dozens of other stock, futures, and options exchanges.

What makes Bakkt different than other Bitcoin futures exchanges is that it is settled in Bitcoin, not in cash.

In other words, bets on whether Bitcoin will rise or fall made using these futures contracts are actually backed by Bitcoin that parties own, stored in Bakkt’s clearing house. The buyers and sellers of these contracts have skin in the game.

This is very different from, for example, the Chicago Mercantile Exchange’s (CME) Bitcoin futures market, where contracts are backed only by cash. This allows traders and institutions to make bets on cryptocurrencies without ever owning them, potentially distorting the market.

However, what caught the attention of concerned traders after Bitcoin broke through its support levels was this:

As you can see, soon after the two last major Bitcoin futures exchanges launched, Bitcoin prices fell dramatically.

That’s more than enough to make traders already looking for a reason to get out to sell.

But there’s more…

On Monday, the same day the Bakkt exchange launched, Bitcoin’s so-called “hashrate” dropped by 40%.

Now, the “hashrate” is the speed at which computers all around the world are running through calculations to create more Bitcoin. A drop that size in hashrate could be seen as a sudden drop in interest in Bitcoin – a clear sign for concerned traders that it’s time to get out.

Except it was nothing of the sort. You see, because Bitcoin is decentralized, there is no way to directly see the hashrate, short of asking every single Bitcoin miner in the world. Instead, statistical methods are used to approximate the number.

That leads to the estimated hashrate fluctuating wildly. Just take a look:

As you can see, the estimated hashrate is extremely volatile. And the drop on Monday could have had many reasons. A string of bad luck could have made the calculations take longer that day. A big Bitcoin miner may have been doing maintenance or upgrading their computers. Maybe there was a flood or fire at a server farm somewhere.

Or, it was just a statistical anomaly in the estimate calculations.

We’ll probably never know.

The important thing is that while the drop on Monday (seen at the right of the chart) was big, in a chart as volatile as this it’s nothing to be concerned about.

Especially as the hashrate recovered the next day and then spiked to all-time highs.

Still, it made traders tht were already scared even more so, and they started selling.

And then the last factor came into play…

BitMEX was the Straw that Broke the Camel’s Back

BitMEX is a Bitcoin exchange run from the Seychelles that prices Bitcoin based on a mix of prices from three other exchanges: Bitstamp, Coinbase Pro, and Kraken.

This means that issues with getting prices from any of those exchanges, as well as other anomalies, can cause havoc with BitMEX’s prices. In the past, this has sent millions of dollars of investments into a margin call.

That happened again on Tuesday, when falling BitMEX prices sent between $500 million and $700 million worth of Bitcoin positions on the exchange into liquidation.

This forced selling sent shockwaves across the Bitcoin world, forcing other exchanges to do the same and driving prices further.

But once all this forced selling clears its way through the system, clearer minds will prevail.

This all goes to show that keeping your emotions out of investing is key to being a successful trader – one of the basic tenets of my 10-Minute Millionaire trading system. In my opinion, the most important key to successful investing is having a tried and true trading system. Right now, just for signing up to be an Insider for as little as $39, I’ll also give you a free copy of my book, which will show you how you can identify your own trades that have a higher probability of success, and how to limit the downside risk that comes with all investing. It won’t be long before you could be enjoying double-your-money trades of your own. Click here to learn more.

This week, Bitcoin traders got caught up in their own pessimism, and sent the market, and their own investments, down.

And as a reminder – we talked before about how bitcoin is not correlated (doesn’t trade like) any other asset. That was proven again here. The double digit percentage drop in BTC didn’t coincide with any other asset class.

That dip will eventually make a good buying opportunity for the rest of us – but not just yet. And it’s also a good reminder to have your stops ready to fire and to keep your cool when you’re trading.

Great trading and God bless you,

D.R. Barton, Jr.

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