Introduction. Any discussion of such an exciting thing as perpetual futures is incomplete without a discussion of cascading liquidations in cryptocurrency perpetual futures markets.
- Several historical events in the cryptocurrency market have demonstrated the devastating power of cascading liquidations, where an initial price drop triggers a chain reaction of forced selling.
- This domino effect has wiped out billions of dollars and caused significant market instability.
- Here are some of the most notable examples of cascading liquidations in crypto perpetual futures:
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May 2021 crypto market crash
- The trigger: A combination of negative news events led to a shift in market sentiment.
- Concerns over the environmental impact of Bitcoin (BTC) mining, exacerbated by a tweet from Tesla CEO Elon Musk, spooked investors.
- Simultaneously, regulatory crackdowns on mining in China further contributed to the fear.
The cascade:
- The initial sell-off caused the price of Bitcoin and other cryptocurrencies to fall sharply, breaching the liquidation thresholds of countless over-leveraged long positions.
- Exchanges automatically sold these positions to cover losses.
- This forced selling created a powerful feedback loop, pushing prices even lower and triggering more liquidations.
The result:
- Over a 48-hour period in May 2021, more than $10 billion in leveraged positions were liquidated.
- Bitcoin's price dropped by over 50% from its high, and many altcoins saw even more extreme losses.
- Terra (LUNA) and UST collapse (May 2022)
The trigger:
- The collapse of the Terra ecosystem was a particularly destructive example of a "protocol-level cascade".
- The algorithmic stablecoin TerraUSD (UST) lost its peg to the US dollar due to large withdrawals.
- This created an arbitrage opportunity that required the minting and selling of Terra's native token, LUNA, to regain the peg.
The cascade:
- As more UST was sold, more LUNA was minted, causing hyperinflation of LUNA's supply. This, in turn, drove the price of LUNA down exponentially.
- Traders and lending protocols with long, leveraged positions in LUNA and UST were forced to liquidate, adding more selling pressure.
- This feedback loop sent LUNA's price to effectively zero in a matter of days, wiping out an estimated $60 billion in market capitalization across the ecosystem.
The result:
- The Terra collapse caused significant contagion across the crypto market, including severe losses for the hedge fund Three Arrows Capital (3AC), which had significant exposure.
Three Arrows Capital (3AC) failure (June 2022)
The trigger:
- 3AC, a major crypto hedge fund, had taken on billions of dollars in debt to fund highly leveraged bets, including a large position in LUNA.
- The collapse of LUNA destroyed a significant portion of 3AC's collateral.
The cascade:
- When the market fell further in June 2022, 3AC was unable to meet margin calls from its lenders, including BlockFi and Voyager Digital.
- These lenders liquidated 3AC's positions, forcing large sales of Bitcoin, Ether, and other assets.
- This triggered cascading liquidations across other interconnected lenders and exchanges, deepening the market downturn.
The result:
- 3AC was eventually liquidated, and its failure sent shockwaves through the industry, contributing to the bankruptcies of other firms.
FTX collapse (November 2022)
The trigger:
- Revelations from CoinDesk exposed the poor financial health of Alameda Research, a trading firm closely affiliated with FTX.
- Alameda's balance sheet was heavily dependent on the highly speculative FTT token issued by FTX.
- When Binance announced it would sell its FTT holdings, it triggered a collapse in the token's price.
The cascade:
- The falling FTT price compromised Alameda's collateral, while revelations of commingled funds and fraud at FTX led to a massive customer bank run.
- The run forced FTX to halt withdrawals and declare bankruptcy.
- This created a liquidity crisis that triggered liquidations across the ecosystem, particularly for firms and traders with exposure to FTX.
The result:
- The FTX collapse caused a broad market downturn, with Bitcoin and other assets reaching multi-year lows.
- The fallout led to the failure of other crypto firms, such as BlockFi, that were intertwined with FTX.
Additional notes on the May 2021 Cryptocurency Market Crash.
The May 2021 crypto crash was a complex event triggered by a confluence of factors, including macroeconomic concerns, influential social media posts, and amplified risk from highly leveraged perpetual futures positions. The final outcome was a devastating market cascade that wiped out billions of dollars and provided a harsh lesson on the dangers of high leverage.
The build-up: A bullish market
- Before May 2021, the crypto market was in a strong bullish phase, with Bitcoin reaching a record high near $65,000 in April.
- This attracted a large number of amateur and professional investors who entered the market with high-leverage trades on perpetual futures contracts, betting on continued price increases.
- This created a "fragile equilibrium" where the market was highly sensitive to any sudden negative shifts in sentiment.
The triggers that broke the market
Several key events created the fear, uncertainty, and doubt (FUD) that initiated the sell-off:
Elon Musk's environmental concerns:
On May 12, Tesla CEO Elon Musk tweeted that the company would suspend accepting Bitcoin as payment, citing concerns over the "rapidly increasing use of fossil fuels" for mining. This surprising reversal from one of crypto's most prominent supporters sent prices tumbling and added fuel to an already jittery market.
Chinese regulatory warnings:
Around the same time, Chinese financial institutions and regulators issued a warning against offering cryptocurrency-related services. This echoed China's past hostility towards crypto and further heightened regulatory fears in the market.
China's crypto mining ban:
A few days later, a high-level Chinese government committee announced an upcoming crackdown on Bitcoin mining and trading. The news signaled a national effort to crack down on mining operations and sent shockwaves through the market.
The crash and cascading liquidations
The market began to unravel rapidly following these negative developments:
Initial sell-off:
The negative news prompted investors to sell their crypto holdings, especially Bitcoin, driving its price down.
Liquidation cascade begins:
The falling prices pushed many highly leveraged long perpetual futures positions below their maintenance margin. This triggered an automatic liquidation process by exchanges, which forcibly sold the underlying assets.
The domino effect:
The large, forced selling from the liquidations added more selling pressure to the market. This drove prices even lower, triggering yet more liquidations. This feedback loop of price drops leading to more liquidations created a devastating downward spiral.
Exchange outages:
During the peak volatility on May 19, major crypto exchange Binance experienced technical issues and outages. This prevented many traders from manually managing their positions or placing stop-loss orders, trapping them and amplifying their losses.
Market-wide collapse:
The panic and forced selling spread across the entire crypto market. Bitcoin, which had been above $58,000 in the first half of May, crashed to around $30,000. Ethereum and other altcoins experienced even more severe losses.
Lessons from the crash
The May 2021 crash highlighted critical risks in the crypto market:
The power of leverage:
The crash exposed how highly leveraged trading, particularly with perpetual futures, could quickly amplify a moderate price correction into a catastrophic market crash.
Market interconnectivity:
It showed how different narratives—from environmental concerns to regulatory crackdowns—could converge to trigger a market-wide liquidity crisis.
The need for risk management:
For many investors, it was a painful lesson on the importance of conservative leverage, using stop-loss orders, and maintaining a sufficient margin buffer
Last Words...
- Learn as much as you can and consider paper trading until you are confident you can win.
- Only trade what you can afford to lose. -Remember you wins are yours and your losses are yours. Take full responsibility for your actions.
As the previous content was the technical explanation and the following was a set of promotional links, I will now structure the promotional content to be clearer and more engaging, integrating the separate elements into logical sections.
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🙋♂️ Author: Shortsegments
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