Investors who borrowed funds at a ratio of up to 100-to-one contributed to the recent wild price swings in Bitcoin, experts and analysts say.
Bitcoin climbed back above $40,000 on Wednesday for the first time this week, but remained 30 percent below its peak price after falling and rising by a third in one day a week ago.
Trading with borrowed funds, also known as leverage or trading on margin, can trigger an automatic liquidation of the borrower’s accounts, called a ‘margin call’, as the lender seeks to ensure that the debt can be paid off.
Mass triggering of margin calls can drive the price of an asset down even further, in a downward spiral – a phenomenon that is exacerbated by the loose lending rules on some cryptocurrency exchanges.
‘Crypto is still a much ‘wilder West’ than any other asset class, where you can trade on some exchanges for up to 50-100X leverage,’ Vijay Ayyar, head of Asia Pacific at Luno, told Bloomberg. ‘What we’ve seen is a big funding reset across exchanges due to overleveraged traders.’
Investors trading with borrowed funds helped drive recent volatility in Bitcoin. Above, a one year view of Bitcoin price shows the recent run-up and sell off
Bitcoin climbed back above $40,000 on Wednesday for the first time this week, but remained 30 percent below its peak
Coinbase, the cryptocurrency exchange that went public last year, only allows margin trading for professional investors, and trading app Robinhood bans it for cryptocurrency trades.
But firms based in Asia, such as BitMEX, allow 100-to-one leverage for cryptocurrency trades, according to CNBC.
During last week’s panicked sell-off, Bitcoin traders liquidated roughly $12 billion in levered positions, wiping out more than 800,000 accounts, according to bybt.com.
‘Selling begets more selling until you come to an equilibrium on leverage in the system,’ JMP analyst Devin Ryan told CNBC.
‘Leverage in the crypto markets — particularly on the retail side — has been a big theme that accentuates the volatility,’ said Ryan.
In addition to small investors, institutional investors played a role in last week’s sell-off, experts say, with large funds that tried to ride Bitcoin’s momentum being some of the first to seek the exit as prices fell.
A one-week view of Bitcoin price shows the sharp sell-off and rebound last Wednesday
On Wednesday morning, Bitcoin jumped as much as 6.5 percent to $40,904. Smaller coins, which tend to rise and fall with the largest cryptocurrency, also gained, with Ether climbing over 7.5 percent to more than $2,900.
Still, Bitcoin is down 30 percent this month, and has lost over 37 percent from its record high of almost $65,000 hit in April. It has gained over 40 percent this year, however.
Among the other drivers of Bitcoin’s recent slump have been fears of a crackdown in China on the emerging sector, as well as concerns over the environmental impact of Bitcoin production, an energy-intensive process known as mining.
Bitcoin plunged as low as $30,066 last week, its lowest since January, in highly volatile trading.
China’s northern region of Inner Mongolia escalated a campaign against cryptocurrency mining on Tuesday, publishing draft rules to root out the business, days after Beijing vowed to crack down on bitcoin mining and trading.
Iran also banned the energy-intensive mining of cryptocurrencies such as Bitcoin for nearly four months, President Hassan Rouhani said on Wednesday, as the country faces major power blackouts in many cities.
According to blockchain analytics firm Elliptic, around 4.5 percent of all Bitcoin mining takes place in Iran, allowing it to earn hundreds of millions of dollars from cryptocurrencies that can be used to lessen the impact of U.S. sanctions.