A flash crash wiped $100 billion from the crypto market in three hours in January 2024. There was another one in March when the BTC-EUR 1% market depth on Coinbase dropped from 60 BTC to 16 BTC before returning to normal. In April, billions of dollars in value evaporated in a few hours.
A flash crash is a brief, sudden, and sharp price movement of a trading pair or a token. On the chart, it looks like a long shadow on a candlestick, similar to a needle.
Why do flash crashes happen?
Flash crashes can happen when many crypto holders suddenly decide to sell, pushing the price down quickly. They differ from regular crashes in that prices recover quickly, often returning to their original levels.
After a flash crash, crypto news outlets tend to dispute the catalyst or culprit. In 2021, Kraken became the scene of a flash crash in the price of Ethereum-based cryptocurrencies. They dropped by over 50% across the board but fully recovered within an hour. Exchange CEO Jesse Powell denied rumors of technical issues, suggesting a whale holder was to blame.
One large player can cause flash crashes, but they are usually the work of many traders moving simultaneously. As prices abruptly drop, panic ensues, and other traders escape to more stable cryptocurrencies or fiat currencies.
They are getting more frequent
A more common cause of flash crashes is beyond human beings’ immediate control. They occur more often as markets increasingly rely on algorithms and automated trading systems. Studies have shown that high-frequency trading can exacerbate price movements during high-stress periods, leading to more crashes.
Trading algorithms produce crashes by triggering one another to sell. This spills into the futures market and triggers a knock-on liquidation cascade, exacerbating the decline.
The first major flash crash was in 2010, followed by big ones in 2013, 2015, 2016, 2019, and 2022. They have been happening every few months.
What to do in a flash crash
Panic selling is the first thing to avoid, as it can lock in unnecessary losses. Traders should be cautious about placing tight stop-loss orders in volatile markets. Consider using stop-limit orders to avoid slippage.
Meanwhile, if the flash crash is suspected to be a temporary anomaly, it may present buying opportunities for undervalued assets.
Avoid executing trades during the height of the crash. Liquidity can dry up, leading to poor trade execution and significant losses.
Use limits instead of market orders to avoid executing trades at unfavorable prices during the crash.
Consider the long-term outlook of your investments. If the fundamentals of your holdings remain strong, it might be wise to hold rather than react to short-term volatility.
