Last Updated: 20 August 2022
The crypto market is entering the weekend with a heavy hangover. Bitcoin is down 7.5%, and Ethereum is down 10%. Many other altcoins are posting deep red numbers today. Due to the declines, the value of the total crypto market is heading towards the 1 trillion euro mark. Is this due to the large number of liquidations?
Crypto market cap close to 1 trillion euros
As it stands, the market cap has dropped by more than 100 billion euros, and is now dangerously close to the psychological barrier of 1 trillion euros — yet another factor that could affect market sentiment, creating more fear in the market.
The chart below is from CoinGecko and is updated on 19 August. The current market cap is 1.06 trillion euros (12 zeros), which is 7% lower than 24 hours ago and marks a 51.01% drop since a year ago.
Not familiar with the term market cap? The market cap of a particular crypto is calculated by multiplying its price by the number of coins in circulation. For example, Bitcoin is now worth 21,000 euros, and there are 19,126,368 BTC in circulation. If we multiply these two, the market cap is 401 billion euros. For comparison, Tesla has a market cap of 943 billion euros.
Do the math for all crypto currencies and add up all the individual market caps, and you will arrive at 1.06 trillion euros. Bitcoin makes up about 40% of the total value of the crypto market. If the bitcoin price dips below 20,900 euros this weekend, then the expectation is that the total crypto market will drop below 1 trillion euros.
By the way, this scenario is quite possible, as there is much less liquidity on the exchanges during the weekend. This means that a few good sales cannot be absorbed by the market just like that.
Do not confuse the term liquidity (amount of money that can be used at short notice) with liquidation (closing a position). The following paragraph is about liquidation in the absence of liquidity.
Bitcoin liquidations worth 470 million
Futures contracts are a relatively cheap and easy instrument to leverage. Do you want to take a bet for 2 bitcoin that the bitcoin price will go higher or lower in the future, but you only have 0.2 bitcoin? Then you can use leverage in a futures contract. You borrow the remaining bitcoin from the exchange which offers this construction.
The danger of using it lies in liquidation, which means that the margin deposit (that 0.2 bitcoin) of the investor becomes insufficient to cover his positions. In these cases, the exchange’s automatic deleveraging mechanism kicks in, and that 0.2 bitcoin utilized as collateral is used to reduce exposure.
A trader can increase his profit by 10x using leverage, but if the asset falls 9% from the starting point, the position is closed. The derivatives exchange will sell the collateral, creating a negative loop known as a cascading liquidation. If the bitcoin price falls, causing positions to be closed, the collateral of these are sold, causing the price to fall even further, and more positions need to be closed, etc.
As the chart above shows, the August 19 sell-off was the highest since June 12. The green bars indicate closed long positions; this is when a trader is betting on a higher price. The red bars indicate short positions, which is, when traders are betting on a lower price.