- The price growth of Bitcoin has been nothing short of truly extraordinary
- Bitcoin recently set a new ATH price above $41,000. In the period between December 8 and January 8, Bitcoin increased by an enormous 117%
- Bitcoin is up almost 350% in the last year, and currently has a market capitalization of $660 billion
- In the article, we consider some of the factors that led to the Bitcoin price correcting to almost $30,000
What caused the big Bitcoin price drop?
While many are extremely happy about the enormous price growth displayed by Bitcoin recently, we always have to be careful when a market turns parabolic. Markets don’t just move up in a straight line. They move in waves, creating peaks and troughs along the way.
Before the recent correction, Bitcoin simply continued to make peaks over with barely any throughs. As the market turned euphoric, it was only a matter of time before a significant price correction would deliver a bit of a reality check.
This is not to say that the Bitcoin bull run is necessarily over. It is just to say that a correction was needed before the market can make a push higher again. The type of bullish momentum displayed by Bitcoin recently is pretty much impossible to sustain over a longer period.
1. The market was clearly overextended and euphoric
It seems this type of sentiment is beginning to gain traction within the market. Before the price correction happened, venture capital investor Chris Burniske warned that the market seemed to be in a state of euphoria, and that a pullback was necessary.
He continued with the following analogy:
3/ A useful analogy here is #crypto‘s bull markets are composed of a set of waves.
In the ocean, a big set can have 3-10 distinct waves that the pack tries to catch.— Chris Burniske (@cburniske) January 6, 2021
He states that after the breakout wave occurs, the water in the ocean needs to dissipate as it must gather its resource to let another wave roll through – that is what is known as the pullback in markets.
Burniske also pointed out that in previous bull-cycles, the pullbacks represented 20-40% declines – which look relatively small today.
We only need to take a look at the weekly chart to look at how parabolic the recent bull trend was:
Bitcoin’s parabolic price action. Image source: TradingView
In fact, if you take a look at the weekly RSI on the weekly chart above, you might notice that the RSI was the most overbought it has been since late-2013 – surpassing the levels seen in the late-2017 market surge. This shows how overextended the bullish momentum was within the market.
2. Retail investors started flooding into the market again, pushing prices higher and making BTC ripe for a correction
There are some other concerns that current BTC investors should be keeping in mind.
Firstly, it seems that mainstream media has noticed that Bitcoin is not “dead,” and headlines are dominating the feeds talking about the extraordinary growth. This is likely to attract amateur retail investors into BTC again. Those that buy and sell without much thought behind their actions. We can already see this in the Google Search Trends for “Bitcoin”:
Google Trends data for the “Bitcoin” search term. Image source: Google Trends
After months of zero interest, there has suddenly been an uptick in Bitcoin searches as retail investors look to catch up with what has been occurring. Furthermore, it seems that Bitcoin price volatility is starting to rise again.
When markets become highly volatile, it is likely to discourage institutional investors from entering any new positions until the volatility dies down. Financial institutional investors mainly drove this latest BTC price boom, so we will likely see a huge pullback if that dries up.
3. Bitcoin futures markets were red-hot and dominated by longs
Lastly, data from The Block (sourced from Skew) shows that the open interest for Bitcoin Futures passed the $10 billion threshold and continues to rocket:
Aggregated open interest of Bitcoin futures. Image source: The Block data dashboard
The aggregated open interest shows the number of open positions on all of the futures exchanges for Bitcoin. The majority of this open interest is sitting on the CME exchange for professional investors, with Binance Futures and OKEx following closely.
Bitcoin futures open interest by exchange. Image source: Skew
As a result of this overwhelming open interest, BTC Futures contracts’ funding rates have gone through the roof. It was estimated that traders were paying over $5 billion in annualized interest fees to keep their long positions open.
The funding rate is the cost that the long traders have to pay the short traders to balance the market. The cost of the funding rate has increased by over 15 times from 0.01% to 0.15%. This is because the majority of the market is overwhelmingly long.
The problem with the majority of the market being long is it gives rise to the probability of a long squeeze occurring. This is a scenario in which long traders (traders with “buy” positions open) have to close their positions when the market starts to fall slightly – usually taking a loss in the process.
To close their positions, these traders need to “sell,” causing a cascade of selling on the futures market, which floods onto the spot market. This leads to a domino effect of Long positions closing by selling the market, usually leading to a large drop in Bitcoin price.
According to Bitcoin market analyst Willy Woo, issues at the Coinbase cryptocurrency exchange played an important role in the recent sell-off. The fact that the Bitcoin price was lower on Coinbase compared to other exchanges due to technical difficulties impacted cryptocurrency derivatives exchanges that use Coinbase as one of their sources for pricing Bitcoin.
Spot market sell off started around $38k, then Coinbase partially failed, not registering buys, causing its price to go $350 lower than others, this pulled down the index price that futures exchanges use to calculate leverage funding, wrecking bearish havoc on speculative markets— Willy Woo (@woonomic) January 11, 2021
The bottom line
In conclusion, I am not trying to bring fear into the market—quite the contrary. I believe Bitcoin will eventually hit $100K per coin in the very near future. This article is just intended to highlight the level of euphoria within the market right now. There is a great deal of greed within the market and many indicators were pointing to the fact that it was extremely overextended.
After a market turns parabolic, there is only one possible outcome – a large pullback. We need to manage our funds wisely to cover ourselves for when this pullback eventually does occur.
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