Crypto flash crashes: what you need to know

A crypto clash crash is an unexpected, sudden, and brief market crash typically caused by algorithmic trading programs.

What is a flash crash in crypto？

In the crypto market, a ‘flash crash’ occurs when a crypto asset experiences a huge sell-off then quickly rebounds in a short period.

This was the case when Ethereums token (ETH) price plunged from over $300 to $0.1 in a few minutes on the GDAX exchange in 2017. A similar case occurred when Ethereum fell by nearly 50% due to a jump in the U.S. consumer price index (CPI) for May 2022. This led to a huge sell-off by large players in the market (whales), causing its price to plummet on the decentralized exchange, Uniswap.

One of the potential solutions to prevent flash crashs that regulators of global exchanges like New York Stock Exchange (NYSE ) and Chicago Mercantile Exchange (CME) have explored is to implement circuit breakers that pause trading activities across the market when an asset drops below 10% in a 15 minute time frame.

However, such measures are quite challenging to implement in the decentralized world of crypto where volatility is high and regulations are minimal. While centralized exchanges can pause trading activities, decentralized exchanges cannot since they arent governed by any central body.

Even if the decentralized autonomous organization (DAOs) that govern do intervene, the damage will often be done as their decision-making process is slow and flash crashes take place in a short space of time.

What causes crypto to crash？

Its quite difficult to attribute the cause of flash crashes in crypto to a single factor, however, they often occur as a result of both human and computer activities.

Humans

In some events, whales facilitate flash crashes as a result of accidental trading, such as a fat-finger error, i.e., unintentionally placing an order at the wrong price or accidentally adding zero.

Sometimes, traders may deliberately employ illegal means, such as spoofing or dynamic layering, when a trader places large sell orders to create the illusion of a huge sell-off and prompt others to begin selling in fear of a potential price decline. The trader will then profit by buying the same asset at a much lower price during the flash crash and selling at a considerably higher price after the asset has rebound.

Computers

Algorithmic trading has created flash crashes in the past and often sets off a cascade of mass liquidation. Certain bots are programmed to use algorithmic solutions that recognize aberrations and automatically execute sell orders to avoid losses.

For example, a crypto asset is trading for 0.5 ETH and a high-frequency trading system has an algorithm that triggers sell orders when the price falls between 0.45 ETH and 0.55 ETH. As a result, a fall in the price to 0.45 ETH will trigger the automatic sell order, which may further push the price lower and continually trigger more algorithmic sell orders as the falls lower.

Examples of flash crashes

Arguably the most notable flash crash occurred in the US stock market on May 6, 2010, when major stock indexes briefly crashed by up to 10%. Since then, flash crashes have happened several times in the crypto markets too.

In 2021, Bitcoin experienced a flash crash where the BTC price plummeted 90% from an all-time high of $67,000 on the Binance exchange to a low of $8,200. The flash crash was attributed to a bug in the trading algorithm of one market paricipant. It also affected other crypto assets like ether (ETH), which experienced a price decline from $4,000 to $2,000.

Coindesk reported another instance of a brief crash in the price of ETH earlier in 2022, where the price fell 15% from about $1,765 to $1,534 in around half an hour and rebounded almost immediately.

In June 2022, Chain token (XCN) lost over 90% of its value before recovering most of the losses later in the same day. The event was attributed to a technical API issue as reported by the developers team.

Impact of a crypto flash crash

The impact of a flash crash in the cryptocurrency market can be significant and wide-ranging. Effects can include significant losses for investors, as those caught off guard by the price drop may not be able to exit their positions in time. This can erode confidence in the market and deter new investors from participating.

Crashes may also negatively impact market sentiment, leading to a loss of trust and confidence in the stability and reliability of cryptocurrencies. This can result in decreased trading volumes and liquidity in the market.

Depending on the severity of the flash crash and the underlying causes, there may be long-term effects on the perception of cryptocurrencies as viable investment assets. Investors may become more cautious and risk-averse, leading to reduced adoption and slower growth of the market.

Conclusion

Crypto flash crashes have emerged as a recurring phenomenon in the volatile landscape of digital currencies. The sudden and short price drops can be triggered by a variety of factors including market manipulation, regulatory announcements, or technical glitches, and underscore the inherent risks associated with crypto investments.

While flash crashes can present opportunities for seasoned traders to capitalize on, they also serve as a stark reminder of the importance of risk management and thorough due diligence in navigating the crypto markets.