Last week an Ethereum flash crash caused a sudden dip in Ethereum value. The value of the cryptocurrency dropped from above $300 to $0.10 cents within a few seconds, before recovering soon afterward. Flash crashes are not unusual and have occurred in the stock markets too, but the event has caused increased concern over the stability of virtual currencies.
What caused the Ethereum flash crash?
At around 12:30 pm (Pacific Time), Ethereum value dropped from $317.81 to $224.48 at the GDAX exchange. Thereafter, its value sharply dropped to $0.10 before recovering back to the initial value just a few seconds later. The Vice President of the GDAX exchange explained that the initial dip in value was caused by a huge multi-million dollar short position executed by one of their clients. The drop from $317.81 to $224.48 then triggered about 800 stop loss orders by its other clients who had long positions.
A stop loss order is used by investors to automatically close a position when the value of an asset drops below a certain level. Obviously, a drop of almost $100 was enough to trigger a huge number of stop loss orders. This huge selloff was then responsible for the subsequent drop in Ethereum value causing the Ethereum flash crash. After the crash, prices rebounded back above $300, but the damage was already done.
Officials from GDAX then stated that there was no wrongdoing and that the exchange’s matching engine was just responding to demand and supply forces. As such, the exchange was not going to reverse the transactions, as it would go against the GDAX Trading Rules. However, today the GDAX VP Adam White said that the company would compensate its clients for the losses following the Ethereum flash crash. The company would not reverse the transactions, but those accounts stopped out would be credited with the equivalent value of ETH/USD prior to the Ethereum flash crash.
The move is obviously a sort of bailout because the funds would come from the company, and this has elicited mixed opinions. On one hand, losers are glad they haven’t lost their investment. There those who made a profit from the Ethereum flash crash. By buying Ethereum when the cryptocurrency was valued at 10 cents, the rebound to $300 could have generated returns in the millions. This group would benefit doubly from both the bailout and investment. On the other hand, a bailout could set a precedent where losers are compensated by the exchange.
What does this mean for Ethereum?
Many investors lost money when their positions were closed automatically, causing major losses. Today, Ethereum has lost more than 20% of its value from above $310 to around $250. The decrease in today’s value was partly caused by the Ethereum flash crash that has got investors worried about the cryptocurrency’s stability. Many investors have now learned that cryptocurrency exchanges are not as developed as the stock exchanges and that they are susceptible to such enormous swings. This is the same reason major investment banks and hedge funds are staying away from cryptocurrency.
There were also other rumors that led to the 20% drop in Ethereum value, like the speculation Vitalik Buterin had died in a car crash. The Ethereum co-founder squashed this rumor by posting an image on Twitter with a blockchain code. Another more plausible reason was just that Ethereum was undergoing a correction. We have stated previously how some experts believed Ethereum was overvalued, and this may be the correction.
The result of last week’s Ethereum flash crash and today’s correction could spell short-term doom for the cryptocurrency. Investors who were already skeptical now have good reasons to be while current investors may be frustrated. The main lesson learned is that cryptocurrency exchanges may not be suited for huge volumes, and without these high-net-worth investors, Ethereum value may only rise slowly in the meantime.