Flash crash is a lingo from traditional finance referring to an unexpected, sudden, and brief market crash typically caused by algorithmic trading programs. Arguably the most notable flash crash occurred in the US stock market on May 6, 2010, when major stock indexes briefly crashed by up to 10 percent. Since then, flash crashes have happened several times in the crypto markets too. Read on to learn about cryptocurrency flash crashes and what causes them.
What Is a Flash Crash in Crypto?
In the crypto markets, a “flash crash” occurs when a crypto asset experiences a huge sell-off and rebounds quickly within a short period. It’s quite different from the regular price decline as it’s subsequently followed by a swift price recovery.
This was the case when Ethereum plunged from over $300 to $0.1 in a few minutes on the GDAX exchange in 2017. A similar case occurred when Ethereum’s token price fell by nearly 50% due to a jump in the U.S. consumer price index (CPI) for May 2022. This led to a huge sell-off by whales, causing its price to plummet on the decentralized exchange, Uniswap.
One of the potential solutions to prevent flash crashs that regulators of global exchanges like NYSE (New York Stock Exchange) and CME (Chicago Mercantile Exchange) have explored is to implement circuit breakers that pause trading activities across the market when an asset drops below 10% in a 15 minutes time frame.
However, it’s quite challenging to implement such in the decentralized world of cryptocurrencies where volatility is high and regulations are minimal.
While centralized exchanges can pause trading activities, decentralized exchanges can continue running since they aren’t governed by any central body. And even if the DAOs that govern them can intervene, the damage would have been done as their decision-making process is slow – flash crashes don’t stay for an extended time.
What Causes Flash Crashes?
It’s quite difficult to attribute the cause of crypto flash crashes to a single reason. However, it often occurs as a result of both human and computer activities.
In some events, large players in the market (whales) facilitate flash crashes as a result of accidental trading, such as a fat-finger error (unintentionally placing an order at the wrong price or accidentally adding zero).
Sometimes, traders may deliberately employ other illegal means like spoofing or dynamic layering, when a trader places large sell orders to create an illusion and fake impression of a huge sell-off to prompt others to begin selling in fear that the price will decline. The trader will then profit by buying the same asset at a much lower price during the flash crash and selling at a considerably higher price after the asset has rebound. Hence, enabling them to make a profit in a short period.
Algorithmic trading has created flash crashes in the past and often sets off a cascade of mass liquidation. Some bots are programmed to use algorithmic solutions that recognize aberrations and automatically execute orders based on them to sell to avoid losses.
For example, a crypto asset is trading for 0.5 ETH and a high-frequency trading system has an algorithm that triggers sell orders when the price falls between 0.45 ETH and 0.55 ETH (to minimize loss and make a profit respectively). This implies a fall in the price to 0.45 ETH will trigger the automatic sell order, which may further push the price lower and continually trigger more algorithmic sell orders as the price goes down.
Examples of Flash Crashes
In 2021, bitcoin experienced a flash crash where the bitcoin price plummeted from an all-time high of $67,000 a day before and plunged nearly 90% on the Binance exchange as the price dropped to as low as $8,200. The flash crash was attributed to a bug in the trading algorithm of one market paricipant. It also affected other crypto assets like ether (ETH), which experienced a price decline from $4,000 per ether to $2,000.
Coindesk reported another instance of a brief crash in the price of ether earlier in 2022, where the price of ETH fell 15%. It dipped from about $1,765 to $1,534 in about half an hour and rebounded almost immediately.
Just last month, Chain token (XCN) was not an exception as it lost over 90% of its value before recovering most of the losses later in the day. The event was attributed to a technical API issue as reported by the developer’s team.
Are Crypto Flash Crashes a Form of Market Manipulation?
While a flash crash in crypto may be caused by market manipulation, other factors like technical glitches and failure of algorithms can also influence the occurrence of such events.
Can Traders Profit from a Crypto Flash Crash?
Some crypto traders see flash crashes as an opportunity to make a quick buck before the price rebounds. However, such trading is quite risky as it’s difficult to detect if a sudden drop in the price of a coin is a flash crash or a longer lasting price correction.
Has Bitcoin Ever Experienced a Flash Crash?
Yes, bitcoin has been subject to flash crashes on several occasions. The most recent bitcoin flash crash occurred in December 2021, when long positions worth about $2 billion were wiped out from the market.