Detecting and Protecting Against Market Weaknesses: A Case Study
Bitcoin fell from nearly $50k last Sunday to below $33k at one point on Wednesday: another reckoning which caught many crypto traders and investors totally off-guard… but not all… For experienced traders, what occurred was long overdue, and indeed anticipated.
The price collapse was eventually triggered by a news announcement from the PBOC (People’s Central Bank of China) banning crypto trading. This alone does not warrant the type of market reaction we saw in recent days; indeed if this announcement occurred at the same time Elon Musk mentioned he purchased Bitcoin for Tesla’s balance sheet, or at the time when Paypal announced they will facilitate Bitcoin payments, the market most likely would have rallied 10% on the day. The PBOC announcement by itself doesn’t change much, trading volume will simply shift somewhere else: what it did was reveal an underlying weakness which had been built up in the markets over the course of a few months.
These market weaknesses are exactly the type of thing that we at SingularityDAO are focused on detecting, and helping investors and crypto traders avoid. Our “majors” DynaSet, with exposure to BTC and ETH, has built-in factors which are looking for these types of risks, and when they are present, reweighs our DynaSets so our investors are protected. In the future we will hopefully be able to gain from these types of events, but for now I think protection suffices. The charts below show how our majors ETH-BTC DynaSet would have performed relative to Bitcoin and Ethereum since the start of the year.
The first sign something was wrong was the level of longside positioning and overly leveraged money which entered the market. Due to liquidity injections, excess capital had flown into crypto markets causing asset prices to rise. The second variable was a highly complacent psychological outlook that only sees $100–500k price targets and does not take into account the fluid and dynamic nature of markets. The third variable was the fact that people so blindly and wholeheartedly made investment and trading decisions based on one person’s tweets… This dynamic is the most dangerous and worrying aspect of how these markets are trading. If one person can hold so much influence over an asset’s price, and people begin to stake their financial future on it, a dynamic builds where people look to one source for direction and ignore anything else which suggests the opposite. The market has a very consistent track record of punishing arrogance and complacency. When people start to say “have fun staying poor”, they are building resentful energy against themselves which, through the universal laws of karma, backfires in their faces.
Back to the technical picture: Bitcoin buyers became overconfident that they had Elon Musk and other institutional backers behind them. This led to high spec activity to concentrate in the market. Aggregated open interest on futures contracts rose to a high of $17 billion in May 2021, suggesting a highly crowded long position. At this point, the market needed more positive fuel to continue its price trajectory. The Coinbase IPO didn’t provide the fuel — and that’s when institutions started reducing long exposure. Then something interesting happened: Elon Musk revealed a few weeks ago that he sold some of his Bitcoin position to “demonstrate liquidity”!
This was the first warning sign for the market, but people didn’t pay attention to the implications. Musk then made things worse: saying that Tesla would no longer be taking Bitcoin payments due to environmental concerns. A Twitter war broke out between the Bitcoin community and their previous comrade. Some dubbed him a traitor. All I saw was a removal of a bullish underpinning factor which had been governing price action, on top of an overly congested long-side position which had been built up. Figures were showing open interest on exchange futures contracts still aggregated in the $12 billion range. This set the market up for a state of sensitivity: any bearish comments could have flipped the market down at this point. Musk tried to reassure markets he didn’t sell the remaining portion of his BTC holdings, but the damage was already done. He lost the faith of the community, and the investment funds that were not already out or hedged were losing patience with the resulting chaos. Then, Bank of America released its monthly fund manager survey report showing that 75% of funds feel Bitcoin is the most overcrowded trade, and is currently trading in a bubble. This was a signal for any fund that still had BTC exposure to sell.
Markets need to release positions, empty up and refuel. When they are not allowed to do this, due to complacent one-sided price views, they become congested and crowded, and the laws of physics eventually take over with more force than usual. Traders saw this, the build-up of Put options contracts as smart longs hedged, and predatory traders went in for the kill. The market was short Gamma on options which attracted further attention from traders to build into short positions to trigger dealer hedging. The PBOC announcement was the final trigger to break the market. Wednesday saw $2.18 billion USD liquidated across crypto exchanges according to data from coinalyze.net. This figure does not take into account CME futures liquidation.
SingularityDAO uses AI-derived insights into markets to anticipate these sorts of movements before they happen. Our modeling of the recent crash validates some of these claims. By trading on a good understanding of what the data mean for the future, we are able to avoid these traps before they happen.
About SingularityDAO
SingularityDAO is a decentralized platform, governed by the SDAO token, tasked with governing DynaSets. DynaSets are diversified baskets of cryptocurrency assets dynamically managed by AI and curated by the protocol. SingularityDAO brings the financial sophistication of AI-managed funds to DeFi, deploying SingularityNET’s AI technology to navigate complex markets.
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