Ask CryptoVantage: What’s Causing the Huge Price Swings in Bitcoin Lately?

Margin Trading

While we can’t say for sure what the primary driver of bitcoin’s price swings is, margin trading is certainly a possibility. Margin trading – also known as trading with leverage – is done by depositing money into a specific type of trading account and then leveraging that money by borrowing against it. In practice, this lets you trade using more capital than you have available, and it amplifies gains and losses. For example, if you make a profitable trade, you will make more money than you would have doing normal trading. On the other hand, if you lose money on the trade, you lose more than you would have normally because in addition to losing money on the trade, you have to pay back the money borrowed for the trade.

In a margin trading contract, people are either betting that the price of bitcoin will go up or down. If someone is betting that the price will go down (also known as “shorting” bitcoin), their margin position will be liquidated if the price goes higher than a certain threshold. This means that they are forced to buy bitcoin to cover their position. When many short positions are liquidated, the additional buying pressure causes the price of bitcoin to go up. This can create a cascading effect of people who are shorting bitcoin being forced to buy once the price threshold in their contracts is reached. This increasing buying pressure can cause bitcoin’s price to continue to increase.

On the other hand, when people are betting that bitcoin’s price will go up (“longing” bitcoin), it can have the opposite effect of shorting. For example, if someone is betting that bitcoin’s price will go up, and then bitcoin’s price drops below a certain threshold, their long position will get liquidated. This means that they are forced to sell bitcoin to cover their position. When many long positions are liquidated it can cause selling pressure, which can move the price of bitcoin downwards. Similarly to shorting bitcoin, this can create a cascading effect but in the opposite direction. People are forced to sell bitcoin once their long position price threshold is reached, continually causing bitcoin’s price to go down.

There are billions of dollars worth of bitcoin being margin traded. The cascading effects of both short and long margin positions getting liquidated often amplifies the price movements. In addition to the margin trading effects, when cascading margin calls cause the bitcoin price to drop, it can also cause panic selling where people start selling bitcoin just because the price is dropping. And when short positions start getting liquidated and the price jumps, people begin to buy based on the fear of missing out on owning an asset that is increasing in price.

Common Catalysts for Price Movements

Cascading margin calls are likely responsible for the magnitude of bitcoin’s price swings, but what causes the price movements to begin in the first place? It can happen naturally, but often there is a catalyst that initiates the big price movements.

In recent months, Elon Musk, one of the richest people in the world, has been very vocal about bitcoin. First, it was announced that his company Tesla would be converting $1.5B of their cash reserves into bitcoin and accepting bitcoin as payment for their electric vehicles. These announcements seem to have to acted as catalysts for bitcoin’s price to go up, which likely caused cascading short positions to get liquidated, further amplifying the upwards price movements. Later, Musk began criticizing bitcoin over its energy usage, and even though Tesla didn’t sell their $1.5B of bitcoin, they announced they will stop accepting bitcoin as payment. This announcement acted as a catalyst for bitcoin’s price movement to go down, which led to the liquidation of long positions, further amplifying the downwards price movements.

Elon Musk’s announcements – often via Twitter – are just one example of catalysts for bitcoin’s price movements. In reality, factors that affect bitcoin’s price movements are much more complex. It is not always as simple as Elon Musk’s tweets causing the price to go up or down, but it serves as an example of the types of situations that can initiate major price swings in bitcoin.

Other examples of past catalysts for bitcoin’s price movements include:

• Rumors that China is banning bitcoin. This has been one of the most common catalysts for downwards price movements throughout bitcoin’s history. However, in recent years it has had less of an impact on bitcoin’s price as the currency has matured.
• Media exaggerating about bitcoin’s environmental impact. This has been a trigger for some downwards price movements as people feel compelled to stop owning bitcoin for ethical reasons.
• Institutions buying large amounts of bitcoin have triggered upwards price movements because they create a sudden increase in buying pressure.
• Often the price movements themselves can be catalysts for future price movements. When the price is going up, it creates more buying pressure as more people are drawn to purchase bitcoin. When the price goes down, it creates more selling pressure as people panic sell.

Final Thoughts

Bitcoin does not have a central authority such as a bank or government to dampen the price volatility. This means that when bitcoin has big price movements, they tend to happen fast and are bigger than many people are used to. While a 5% change in the stock market is considered a large daily move, it is not uncommon for bitcoin’s price to rise or fall more than 20% in a day.

You can easily lose a lot of money due to bitcoin’s price swings if you only plan to hold it for a short while. Bitcoin is much better to be used as a long-term store of value rather than a short-term investment. Throughout bitcoin’s 12-year history, buying and holding it for 4+ years has always been a profitable move.