Brokers and experts claim that Wall Street is utilising tried-and-true strategies to get ready for the upcoming wave of cryptocurrency volatility.
So far this year, Bitcoin has decreased by around 60%. Many predict that the current choppy market will become considerably more so, possibly even before 2022 is over.
Investors in cryptocurrencies are using leverage once more. In 2022, the price of bitcoin and other digital assets has fluctuated significantly, driving a number of well-known crypto companies into bankruptcy. Additionally, it has created the kind of environment that allows shrewd, wealthy traders to prosper.
Market observers claim that institutional traders are using some of the same strategies that helped them succeed in conventional markets, including equities and commodities. This could entail shorting a security to bring about a wave of margin calls and forced selling, or it could entail following the activities of other significant investors.
DeFi transactions are publicly accessible on a digital ledger, making it possible for anyone with the proper resources to find them even if the counterparties are concealed. According to cryptocurrency investors, brokers, and experts, this has provided skilled traders with a wealth of data they can use.
The key distinction with cryptocurrency is that users of so-called decentralised finance platforms don’t need banks or brokers to carry out transactions or borrow digital assets. Instead, things are basically performed by computer code.
Since DeFi loans are automated, many of them are overcollateralized, which means the value of the provided collateral exceeds the loan amount. However, the software platform immediately calls the loan if the value of that collateral drops below a particular level. In a margin call, if the borrower doesn’t post more, the platform will sell the borrower’s collateral, which is a digital currency. If an investor received a margin call from a bank or broker, there is rarely opportunity for bargaining over such terms.
The gain in bitcoin and other digital currencies encouraged crypto investors to borrow more money to expand their holdings, which raised the opportunity to drive these loans into liquidation and unleash a wave of forced selling.
Ethan McMahon, an economist at Chainalysis, a maker of software that tracks cryptocurrency transactions, noted that cryptocurrency investors had increasingly turned to DeFi lending platforms last year to avoid the due-diligence requirements and leverage limits imposed by centralised brokers and lending platforms and to deal in a wider array of digital assets. The market’s sharp selloff earlier this year, according to analysts, was when trading tactics based on taking advantage of the data contained in loan contracts were more common.
According to Alex Thorn, head of research at Galaxy Digital, an investment bank that specialises in digital assets, when falling prices brought sizable loans on DeFi platforms to the verge of liquidation, crypto investors flocked to social media and online forums to gawk and speculate over the identities of the borrowers. After the selloff wiped out most of the leverage that had been accumulated during the crypto market’s 2021 rise, many of the opportunities to profit from that knowledge vanished. According to Chainalysis, the total amount borrowed on DeFi in December 2021 was close to $80 billion. According to Chainalysis, at the end of July, this amount had fallen to $6.91 billion, the lowest level in almost two years.
Leverage has increased, with DeFi loans reaching $12.76 billion on September 30. Trading businesses will also be scrutinising the investors who return to those platforms. More loans, transactions, and positions with liquidations will occur, according to Thorn. “As DeFi activity increases, so will the use of sophisticated trading tactics.”
One such tactic involves traders obtaining a digital currency on loan with the intention of selling it. These short sales assist in lowering the asset’s price, maybe below the threshold at which a number of DeFi loans must be repaid in full. The forced selling lowers the value of the currency even further. The hunters in those marketplaces make an educated guess as to the prices at which other investors have told their brokers to sell a certain item. These stop-loss orders reduce losses when there is a selloff. Traditional market traders aren’t aware of the orders, but they can assume that a few of them will be placed to round figures, for instance, when a stock falls below $100.
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