Coinbase Analysis 3/12: Despite the chain reaction of traditional financial market crashes, Bitcoin remains a "hard asset foundation"

Bitcoin was born in the 2008 financial crisis, but as it faced the closest thing to a financial crisis in 10 years, Bitcoin not only did not show its hedging characteristics, but also plummeted along with various asset classes. The industry also began to question Bitcoin's intrinsic value, asset attributes, and even its scarcity. Therefore, Coinbase, starting from the perspective of the traditional financial market, explained how the collapse of the traditional financial market affected the cryptocurrency market, and revealed how retail investors responded during and after the crash.

This article is translated, the original is from "On the Recent Market Crash and Bitcoin’s Value Proposition", sourced from Coinbase's blog on March 31st.

Below is the full article from Coinbase Blog:

Advertisement - Please scroll down for more content

Bitcoin (BTC) and other crypto assets fell by about 50% on March 12th this month, marking the largest single-day drop for Bitcoin since 2013.

As concerns about the impact of COVID-19 on the global economy grew, the sharp drop that day wreaked havoc on the financial markets, with the S&P 500 and Dow Jones Industrial Average both plummeting nearly 10% in a single day, the largest drop since Black Monday in 1987.

Amid wider economic turmoil, the public is increasingly seeing Bitcoin as a potential safe haven asset. Although Bitcoin is generally considered an unrelated asset, at the moment of verifying its capabilities, the Bitcoin market still collapsed by nearly 50%. What happened?

From a Macro Market Perspective

First and foremost, we should examine the situation from the perspective of traditional financial markets. Prior to March 12th, the World Health Organization declared the novel coronavirus outbreak a "global pandemic," President Trump imposed a 30-day travel ban on Europe, and the Italian Prime Minister enforced a nationwide lockdown. People began to realize the severity of COVID-19, and it became evident that our global economy was not equipped to handle such a massive impact, leading to an instantaneous market collapse.

Understanding the market psychology at this moment is crucial. When the market experiences a sharp decline, investors naturally seek "safe-haven assets." However, every investor rushing to sell off their assets in haste triggers an immediate liquidity crisis, with sellers vastly outnumbering buyers, further exacerbating the market crash.

What's worse is that many large holders have leveraged positions, where the borrowed value of $2 to $3 is actually supported by only $1. When the market crashes, these leveraged positions are on the brink of bankruptcy and face liquidation crises, leading to further USD shortages.

Due to widespread selling coupled with a substantial deleveraging event, there was a strong demand for cash. At that moment, investors were not just selling the assets they wanted to offload, but everything they could sell, including Bitcoin and other cryptocurrencies, causing massive losses across all liquid markets on March 12th.

Let's Talk About What Happened to Bitcoin

The reasons behind Bitcoin's collapse are similar. Some short-term speculators sold off, institutions needed cash to meet margin calls, and some leveraged positions were forced to liquidate. However, Bitcoin saw a more drastic drop compared to traditional markets due to the extent of leverage in the Bitcoin space.

In traditional stock markets, leverage is typically limited to around 2-3 times. In contrast, some offshore exchanges offer leverage of over 100 times in the Bitcoin realm, meaning that $1 worth of Bitcoin can have a buying power of $100. This is highly risky; even a 1% adverse move in the position could lead to forced liquidation of a 100 times leveraged position. While most traders hold positions at a more reasonable 5-30 times leverage, it is still significantly higher than the 2-3 times in traditional markets.

Leverage is also present in other products: miners often take out loans collateralized with Bitcoin, and more advanced traders use leverage for futures contracts trading.

Prior to the market crash, the total size of leverage contracts on exchanges was approximately $4 billion. This scale was sufficient to trigger significant downward movements, causing additional price volatility. While declines are usually welcomed by buyers in trading markets, the panic on March 12th turned all buyers into sellers. As prices dropped, more leveraged positions were forced to liquidate, leading to a new round of selling pressure matching the subdued demand, further driving prices down and resulting in more asset liquidations, creating a "chain reaction."

BitMEX, which offers high leverage derivatives, experienced the most pronounced chain reaction. During the sell-off, Bitcoin trading prices on BitMEX were significantly lower than on other exchanges. The chain reaction abruptly halted when BitMEX went offline for maintenance (claiming to be under a DDoS attack) at peak volatility, and prices quickly rebounded.

After the dust settled, Bitcoin briefly dipped below $4,000 and hovered around $5,000.

This situation sparked debates, with some arguing that standing idly by in such an unregulated environment, the high leverage trading readily available to retail investors could pose risks to the crypto asset space. Although high leverage played a crucial role in the crypto market on March 12th, we hope that these circumstances will improve as the crypto market matures, whether through external regulatory oversight or industry-led initiatives.

If the steep drop was driven by a widespread liquidity crisis, and the extreme leverage in cryptocurrencies exacerbated the situation, how did Coinbase users react?

During and in the 48 hours following the drop, we witnessed record-breaking numbers compared to the average of the past 12 months:

• Cash and cryptocurrency deposits increased fivefold, totaling $1.3 billion
• New user registrations doubled
• Trading users tripled
• Total trading volume increased sixfold

Amidst the chaos, two things are clear: during the drop, our main users were buyers, and Bitcoin was evidently the most popular. While our user base typically sees buy orders outweighing sell orders by 60%, during the crash, this ratio surged to 67%, demonstrating users' demand for cryptocurrencies at discounted prices.

Bitcoin was the most popular, with over half of the deposits and trades involving it. The appeal of other cryptocurrencies also increased, with Ethereum (ETH) and Ripple (XRP) ranking as the second and third most popular assets, respectively. This also included newer cryptocurrencies like Tezos and Chainlink, as well as established ones like Litecoin and Bitcoin Cash.

Conclusion

For crypto enthusiasts, witnessing price crashes and the seismic impact on the industry ecosystem is distressing. In these moments, it's natural to blame oneself for mistakes made, and you may have had such thoughts.

However, in certain situations, we know that broader mechanisms are at play. Fear drove many investors to cash out, triggering severe liquidity tightening (cash becoming "expensive"), decoupling prices from fundamental values, and leading to almost all asset classes deleveraging. Bitcoin was not spared, suffering the most severe blow due to the deployed leverage scale and scope, causing a series of liquidations.

Since the drop, Bitcoin and the broader cryptocurrency ecosystem have recovered, while stocks continue to decline (as of March 27th, S&P -6% vs. Bitcoin +23%). Coinbase specifically highlights user buying behavior during and after the drop.

This scenario has occurred before. During the 2008 financial crisis, gold initially plummeted over 30%. It wasn't because it was an inferior store of value, but because a similar liquidity crisis affected gold. Its value stood out amid broader financial turmoil, and gold continued to triple in value over the next three years.

Bitcoin was created in a similar economic backdrop. Its Genesis Block bears the message, "Chancellor on brink of second bailout for banks," paying homage to the 2008 government bailouts and the previous major financial crisis, echoing the demand for sovereign currency without any centralized intermediaries.

As the US government shifts towards negative interest rate policies, massive stimulus packages, and unlimited quantitative easing (QE), Bitcoin will take a completely opposite approach in the next block reward halving adjustment, making a clear distinction.

For many, Bitcoin is the hardest form of money in existence, with only 21 million in circulation, collectively controlled by its participants, and no central authority can influence its supply or adjust interest rates. Ultimately, Bitcoin's value proposition should not be defined by the dynamics of external markets but by its unique attributes, making it potentially an attractive store of value asset.