WTF just happened!? Bitcoin's first major Bull Market correction
Quick recap of this morning's mayhem
I paid >$1,100 in Ethereum gas fees to rescue a loan from liquidation. How did your morning go? In all seriousness, this is not at all a humble brag. It was painful, got my heart rate and blood pressure up to danger levels, and a lot of people lost money. Since the April 14th high, Bitcoin’s price has fallen from $64,830 to a low of $29,930, a -54% correction from wick to wick! Crypto is not for the faint of heart and I expect many new investors will be gone for good. Most of us crypto natives have lived through these shakeouts as it’s part of the maturation of a market, and are optimistic. A common phrase, ‘zoom out’ is useful on days like today.
Leveraged yield farming
I have written about how Ethereum ($ETH) is the most productive asset in our lifetime, and I often lend it out as collateral to borrow assets for yield farming. It’s great because I have exposure to the longterm price appreciation of ETH, and get to use it as collateral. The interest rate to borrow assets always pales in comparison to the earning potential in DeFi, so it’s a positive expected value strategy. I’m currently borrowing stablecoins to farm CVX tokens and watched my Aave Health Factor drop to the danger zone. I had to deposit addtional collateral to increase my health factor, and it cost me A LOT of ETH during maximum Ethereum transaction congestion. When Ethereum gets very congested with transactions, costs skyrocket even higher than when prices are relatively stable. This is a big problem.
On Polygon, I had an Aave Health Factor drop to <1, which would imply liquidation if I wasn’t able to revive it. I was able to move funds around in less than a minute and for fractions of a cent. This was a an amazingly stark contrast from the Ethereum mainnet.
Who were the losers today:
Leveraged traders
Many traders like to gamble and can make big bucks by using 5, 10, or even 100X leverage. This means they borrow money from other traders and crypto exchanges to increase their upside. When prices crash, the exchange automatically liquidates their position to recover the borrowed money. This is a market sell, and makes the price crash even harder.
Irresponsible (uninformed) borrowers
Using leverage in DeFi is powerful as it allows you to be productive with your digital assets. Popular protocols like Aave, Compound, Maker, and others allow depositors to instantly borrow assets in a trustless manner. However, if you aren’t watching your collateralization ratio (typically needs to be >150%), your deposit will be sold to cover the borrowed position. This usually comes with a 15% fee on top, and it can be extremely costly. It’s wise to watch your borrow health factor and always keep a big buffer - I never go below 200% collateralization.
New crypto funds
Don’t worry, cryptocurrency is a long game, and many call it a generational investment opportunity. Unfortunately, market dumps can make it difficult due to the volatility and timing, which is why profit taking is a wise strategy. DeFi has the added benefit of stablecoins and high yield investment strategy. This removes the underlying principle risk of crypto, but still provides great returns (~5-20%).
Who were the winners today:
Centralized crypto exchanges
Trading volume was huge and exchanges get a piece of every transaction. Also, liquidation fees probably piled up!
Dip buyers
This has been a winning strategy across both traditional and crypto markets over the last decade. Cryptocurrency is a nascent market, and there is plenty of upside left. This might be the market cycle top, but I expect digital assets to be part of the future economy and appreciate over time.
Liquidation buyers
DeFi lending protocols like Liquity and Maker allow users to purchase liquidated positions at a huge discount. There hasn’t been an opportunistic purchase event like this since the COVID crash in March, 2020.
What’s next?
A healthy market correction
Historically, Bitcoin has had multiple 30-40% drawdowns during bull markets. This is required to wipe out irresponsibly leveraged traders (gamblers), shake out the weak hands/non-believers, and provide good entry prices for those who missed earlier buying opportunities.
Side chains and Layer 2 scaling solutions are going to take off
Aave has already deployed on Polygon and there is >$5 billion in liquidity in under a month. Polygon is a ‘side chain,’ which is separate from Ethereum, and it does not benefit from the Ethereum chain security. Here’s a good thread about how it works:
The market (customers) require cheaper transaction fees and it will be much safer to leverage crypto assets when there are liquidity crunches.
Optimism and Arbitrum (Ethereum Layer 2 solutions) will be deployed to mainnet in a few weeks time.
Fundamentals have not changed! As an Ethereum expert, I expect 4 catalysts for Ethereum continuing upwards and eventually flipping Bitcoin.
EIP-1559 - fee burning coming in July
DeFi locking up ETH
The Proof of Stake merge in November
Ethereum will be 99.95% more energy efficient than Bitcoin
Finally - Bullish news:
Ark Invest disclosed they are holding $ETH. I anticipate other major investors and public companies will follow suit.