What You Need to Know About Crypto Flash Crash

The “flash crash” concept represents a sudden and drastic price drop within a very short time frame, in this case, catching cryptocurrency traders and investors off guard. As opposed to traditional market downturns, these crashes are characterised by a swift recovery, often returning to their original price levels almost as quickly as they plummeted. 

But what are the causes of these dramatic events, and how can investors protect themselves?

The Mechanics Behind Flash Crashes

The crypto market may experience a flash crash if a significant amount of assets is liquidated abruptly, overwhelming the buy-side and precipitating a steep drop in price. 

Back in 2021, Ethereum-based tokens experienced a price decline of over 50% on the Cryptocurrency exchange Kraken. This particular crypto price change was quickly corrected, and a full recovery took place in less than an hour. These crashes can be caused if large investors are selling off their holdings or even algorithmic trading programs going through a self-reinforcing sell-off.

Algorithmic Trading

Algorithmic trading programs are designed to make high-speed trading decisions based on pre-set criteria on the market volatility in the said cryptocurrency. These programs can trigger a sell-off in response to certain market conditions, which in turn prompts other algorithms to immediately sell, thereby creating a feedback loop that rapidly drives prices down. 

Market Manipulation

Unbeknownst to many, flash crashes may be a result of deliberate market manipulation. Large investors, or for lack of a better word, “whales,” may employ strategies like “stop hunting” or create artificial buy/sell walls to influence the market in their favour. These tactics can lead to sudden market movements that cause a flash crash as other traders respond to the manipulated conditions.

The Bounce-Back Phenomenon

Interestingly, the aftermath of a flash crash often sees a rapid “bounce back” in prices. This recovery is driven by investors who see the drop as an opportunity to purchase undervalued assets by betting on their inevitable recovery. This pattern is not exclusive to the crypto market but is a hallmark of flash crashes that demonstrates the resilience and opportunistic nature of most investors.

Lessons for Investors

For investors observing the volatile dance of the Cryptocurrency markets, these flash crashes serve as a warning and an opportunity. The key to curb losses lies in due diligence and strategic planning. 

Here are some key takeaways: 

  • Diversification: Spreading investments across different assets can mitigate risk.
  • Risk Management: Setting stop-loss orders can protect against huge losses during sudden drops. But still, be on the lookout for market manipulation tactics that may trigger such orders.
  • Stay Informed: Acquainting oneself with market trends and news from reputable outlets can help predict potential flash crashes. 
  • Long-Term Perspective: By their nature, flash crashes are brief. Investors with a long-term view may choose to weather the storm by focusing on the potential for recovery and growth over time.

Final Thoughts

Investors must comprehend the complexities of cryptocurrency markets, including phenomena like flash crashes, as the UK pushes forward in the global fintech scene. Investors can confidently manoeuvre these uncertain waters by cultivating a combination of caution, well-informed strategy and opportunity awareness. This will position them to capitalise on the market’s inherent dynamic nature and substantial returns that make sense. 

Image Source: Adobe Stock

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used for legal, tax, investment, financial, or other advice.