Report: Recent cryptocurrency price actions are a domino effect

The cryptocurrency markets have layers. Which one are you in?

There are several different types of players in the crypto markets and getting a holistic view of the market's price movements means looking at all of them. But which ones you can see depends on your vantage point.

The trading on exchanges is just the tip of the iceberg. There's also a lot of money flowing through over the counter (OTC) crypto brokers, which specialise in filling large orders.

Depending on where you look, you get a slightly different picture of the crypto markets. For example, even as exchange volumes dropped off throughout 2018, OTC brokers saw demand skyrocket and moved to scale up their operations.

Australian OTC crypto broker HiveEx (a related business to Finder) explores this viewpoint further in a new report, noting that it "saw a majority skew towards experienced clients taking an opportunity to re-enter the market" from 1 January to 9 May 2019. It may have been a prescient move from those experienced traders since Bitcoin prices are up more than 30% since 9 May.

Other institutional-focused industry heavyweights have had similar experiences. For instance, Grayscale's regular 2018 reports kept entertainingly juxtaposing massive losses with roaring customer growth throughout the year, even as Bitcoin obituaries kept rolling in.

Clearly, different groups are experiencing the market in different ways.

The domino players

You can see the different groups in action following large price changes, observes James O'Donoghue, HiveEx head of operations and growth, and one of the report's contributors.

"Whenever there's a substantially large price movement, you see different groups getting into the market at different times. You get some catalyst, followed by traders, funds and retail speculators, usually in that order," he explains.

The first domino: whales

"Generally with large movements, it's often just one player that’s made the move. That could be a fund, market maker or trading house that has significant capital. These moves often stir a great deal of speculation as people quickly gather to work out what the strategy might have been," O'Donoghue said.

The second domino: traders and bargain hunters

"Following that, you have experienced traders who will trade the volatility," he continued. "They're straight onto it, capitalising on the sharp price movements higher and lower that follow in the wake from uncertainty."

They're joined by long-term investors who hunt for bargains on the troughs of the price waves.

"Many funds who hold a long-term outlook, ranging from a few years to a decade or more, will see the opportunity to buy the dip if it arises in the period after," O'Donoghue noted.

The third domino: retail speculators

"For the most part, the broader category of retail investors tends to wait for some sign of confidence before taking a position. This might be once things stabilise, news breaks that clarifies what happened or after a trend begins to form," O'Donoghue said. "They tend to be more stand-offish in the immediate aftermath [of a big price change], but can be quick to pull the trigger once a fear of missing out kicks in or their confidence in a bigger picture is returned."

One quick, easy and highly unscientific way to highlight this domino effect is to line up Bitcoin prices (top) with Google trends results for Bitcoin (bottom).

On the one hand, they're great mirrors of each other.

On the other hand, if you assume Google trends is a perfect indication of retail interest in Bitcoin, it shows that interest lags behind price changes and mostly comes after prices have already risen. There's also zero interest in buying short-term dips.

And if you squint and use your imagination, that last little uptick on the Google chart, in the absence of an actual price rise, is a case of main-street market-watchers waiting for a sign of stability (Bitcoin sustaining in the $7,900 to $8,000 range) before getting involved.

Who's driving prices?

But if retail speculators don't show up until after prices rise, and if their dominoes are the last to fall, then that strongly suggests Bitcoin prices are not being naturally driven by grassroots interest from retail speculators.

And so whale watching, rather than sentiment spotting, may hold the key to predicting price movements.

"Big players naturally are very strategic in ensuring they maximise an entry or exit from the market... [but] this means big movements can come without warning," O'Donoghue pointed out.

After all, you start a domino run by tipping over a single domino. You don't run along and knock over every single domino by hand. From one angle, that's what's causing those big swings.

"Many speculate that these movements are also often suspicious... and take advantage of the grey area in which cryptocurrency markets operate, utilising practices that could land serious consequences if conducted in more established and regulated markets," he said. "Such methods might include efforts to start a rally with a large buy order after gradually walking the price up... then sitting back and letting the market exaggerate, and carry prices higher, before those responsible exit their position suddenly and leave retail investors holding the bags.

"Big trades can definitely move the market," O'Donoghue said. "We saw this on Bitstamp just the other day when someone ran down the market with a 5,000 BTC sell order, triggering approximately $250 million dollars in liquidations against people holding long positions on BitMEX, who uses Bitstamp as an index for market price."

The M word

It's tough to look at Bitcoin's latest price swings without acknowledging the potential for market manipulation, and both the big rise and the big drop look very much like someone deliberately trying to maximise the price impact of their buying and selling, for whatever reason.

The potential for manipulation in Bitcoin markets might be more relevant now than ever, with the SEC patiently working its way through repeated requests for approval of a Bitcoin exchange traded fund (ETF) and declining almost all applications due to market manipulation concerns.

At this rate, the estimated arrival time for Bitcoin ETFs is never.

It's not entirely clear how to best resolve the issue either. Bitcoin's wealth distribution is very top heavy, and it seems clear that the markets currently aren't deep enough for whales to swim in. The recent price shifts make it clear that Bitcoin is still a very immature asset.

The most likely way forward might simply be more liquidity, more growth and more building out of cryptocurrency infrastructure and hoping for the best. Beyond that, further insights into crypto market movements could inform the development of market surveillance tools.

You can't prevent traders from exacerbating artificial price changes, and probably shouldn't, but you can keep an eye on the first dominoes in line. One simple, but arguably infeasible, unethical and un-Bitcoin solution, would be to dynamically hobble whales based on current market conditions and prevent people from knocking over dominoes in the first place.

In the end, the worst case scenario is that Bitcoin gets killed by its own price manipulation. But looking on the bright side, it would be a very artful demise.

Deliberate market manipulation on Mt. Gox is believed to have been the spark that fired Bitcoin to above $1,000 for the first time, so there would be a neat sense of Bitcoin coming full circle. You have Bitcoin – the world's first immutability machine – being destroyed by price manipulation; the perfect machine undone by humanity's flaws.

It would be so dang poetic if it happened that it's almost a shame it probably won't ever come to that.

Disclosure: Hive Empire Trading Pty Ltd (T/as “HiveEx”) is a related party of Hive Empire Pty Ltd (T/As finder.com.au)

Disclosure: The author holds BTC, BNB, ATOM and IOTA at the time of writing.

Picture: Shutterstock