Forced Sell-Offs of Pledged Cryptocurrencies Turbocharge Price Plunge

The plunge in prices of major cryptocurrencies this week has been driven in part by massive forced sales of cryptocurrencies pledged as collateral for financing, especially those on automated blockchain platforms, industry participants said.

Bitcoin nosedived as much as 30% to $30,000 on Wednesday evening, though it mounted a recovery Thursday. Ethereum (ETH), the second-biggest cryptocurrency by market cap, sank more than 40% on Wednesday night, while internet-meme token Dogecoin lost 50%.

Behind the scenes was the deleveraging of an overleveraged market, Wu Jihan, founder of cryptocurrency mining services platform BitDeer, told Caixin. Wu said that Tesla Inc. founder Elon Musk’s recent U-turn on the electric-vehicle maker accepting payments in Bitcoin, and worries that Chinese regulators could tighten oversight also contributed to the recent sell-offs.

Mass forced sell-offs of cryptocurrencies that investors had pledged on decentralized finance (DeFi) blockchain platforms for financing overloaded the platforms, which made the plunge even worse, industry insiders said.

DeFi is a broad term that covers a variety of applications based on blockchain technology, with the goal of bypassing traditional financial intermediaries. A key element is so-called automated “smart contracts.”

The design of DeFi trading mechanisms likely contributed to the price plunge, as dropping prices can lead to automated mass forced sales of pledged cryptocurrencies, creating a vicious cycle of downward pressure, insiders said.

For instance, investors pledge their ETH holdings as collateral on a DeFi platform to borrow other cryptocurrencies, which they can then use to buy more ETH. A forced liquidation occurs when the ETH price drops to a certain level and the investors do not provide more collateral.

As the leverage in such DeFi contracts is usually not as high as that on centralized trading platforms, which could be 50 or even 100 times the value of the collateral, investors feel these contracts are less risky and often plow more cash into them, Wu said.

However, the plunge did not weaken cryptocurrency supporters’ confidence in the market. “Bitcoin’s current price action is not abnormal for a bull market cycle and that prices could still resume their recent uptrend before forming a longer-term peak,” Matt Weller, global head of market research for online broker FOREX.com, wrote in a note. “While Bitcoin’s current plunge certainly feels terrifying for bulls in the moment, experienced ‘hodlers’ know that Bitcoin routinely sees steep selloffs during bull markets.”

Contact reporter Guo Yingzhe (yingzheguo@caixin.com) and editor Joshua Dummer (joshuadummer@caixin.com)

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