Crypto’s Roller Coaster: The Worst Liquidation Event in History

Friday’s sell-off has created waves in the cryptocurrency market, marking what Bitwise portfolio manager Jonathan Man described as the worst liquidation event in crypto history. This incident saw more than $20 billion wiped off as liquidity disappeared, forcing an undeniable wave of deleveraging across platforms, as detailed in Man’s article published on X.

Understanding Perpetual Futures

At the core of this volatility are perpetual futures, commonly referred to as “perps.” These are cash-settled contracts without an expiry date, designed to reflect the spot market through the mechanism of funding payments rather than physical delivery. Profits and losses are netted against a common margin pool, demonstrating why, in times of stress, trading venues must swiftly rebalance exposure to maintain equilibrium. This architecture is both a mechanism for potential gain and a risky setup during severe market fluctuations.

The Sudden Price Drop

Man reported that Bitcoin plummeted by 13% from its peak within just one hour. Additionally, losses in lesser-known "long-tail" tokens were even more severe. He remarked that ATOM experienced a shocking drop to virtually zero on some trading platforms before recovering. This dramatic slide led to an estimated $65 billion in open interest being wiped clean, resetting market positions back to levels unseen since July.

Examining Market Liquidity

While Joe Public may focus on headline figures, Man stressed that understanding "the plumbing" of the system is crucial. As uncertainty escalates, liquidity providers tend to retract their quotes or withdraw from the market entirely, which hampers organic liquidations. When the market faces extreme stress, clearing stops occurring at acceptable prices, leading to exchanges relying on emergency mechanisms.

Safety Measures Implemented by Exchanges

As exchanges grappled with their liquidity concerns, they leaned on various safety valves. One notable mechanism was auto-deleveraging, which forcibly closed portions of profitable counter-positions when insufficient cash was available on the losing side. This practice ensured that exchanges could manage their exposure and avoid cascading failures.

In a notable mention, liquidity vaults like Hyperliquid’s HLP capitalized on the situation, reportedly enjoying an "extremely profitable day" by acquiring assets at substantial discounts and liquidating them during price spikes.

The Role of Centralized Venues vs. DeFi

According to Man, the most dramatic dislocations were witnessed on centralized platforms due to thinning order books. Consequently, long-tail tokens faced steeper declines than Bitcoin or Ethereum.

Conversely, liquidations on DeFi platforms remained comparatively subdued for two main reasons. First, prominent lending protocols typically accept blue-chip collateral such as BTC and ETH, which helps stabilize the market. Second, protocols like Aave and Morpho have the mechanism to hardcode stablecoin prices to preserve value, effectively limiting cascade risks.

While USDe remained solvent, it traded for approximately $0.65 on centralized exchanges during this tumultuous period, putting users who had posted it as margin at risk of liquidation.

Risks Beyond Market Trends

Man highlighted that beyond directional trading risks, significant concerns arose from hidden exposures in market-neutral funds. In chaotic times, operational risks come to the forefront—issues such as algorithm functionality, the reliability of exchange infrastructure, accurate pricing marks, and the promptness of hedging and margin executions become critical.

Although Man verified with several managers and received reassurance about their stability, he mentioned that some "C-tier trading teams might get carried out" in the pandemonium.

Price Disruption Across Venues

Man also observed an unusual disparity in price across different exchanges, citing spreads exceeding $300 at times between platforms like Binance and Hyperliquid for ETH-USD pairs.

Despite the initial panic, prices rebounded from extreme lows. The flush in positioning created new opportunities for traders who were sitting on liquidity.

With open interest significantly decreased, the markets stepped into the weekend on a relatively firmer ground compared to the chaos of the preceding day.