If you are investing in cryptocurrency, you have probably come across a few terms that explain certain market phenomena. One of those is ‘flash crash’. Found in both traditional asset space and the crypto industry, a flash crash is something that is known to happen and could significantly impact the value of investments in a short amount of time.
Anyone seriously investing in crypto should be aware of how flash crashes work and how to navigate them within the market. In this guide, we’ll break down what exactly a flash crash is, how it can affect you, and if it is possible to prevent it.
What Is Flash Crash About?
At its core, a flash crash is a situation in which an asset market sees a rapid and drastic fall in value, followed by a quick recovery. In other words, a flash crash sees a specific asset or the entire asset market fall sharply and also recover sharply. Notably, a flash crash can begin and end within only a few hours and while it is notable in its initial effects, it usually doesn’t affect the market long-term.
It is also worth exploring what causes a flash crash. Flash crashes tend to be caused by high-value and/or high-frequency traders selling off assets very quickly. Asset market values are driven by supply and demand and if there is a sudden flood of supply from a high-value trader selling off their assets, the price of that asset will drop significantly and automatically. On top of this, many traders use automated systems that are designed to sell off assets if their value falls below a certain amount. This causes the price to fall even more, though the market corrects itself and the price recovers soon after.
This creates a cycle where a big trader sells assets which crashes the price, other traders sell off assets which further crashes the price, and then a market correction occurs. Keep in mind, all these tend to happen in a single day and anyone who wasn’t watching the market might not even know it happened.
Flash Crash in Crypto
Flash crashes uniquely operate within the crypto market. Just like ‘traditional’ flash crashes, crypto flash crashes see a crypto asset lose a significant amount of its value in a short period and then recover soon after.
The cause of flash crashes in the crypto industry tends to be crypto whales – those who hold a large amount of crypto at their disposal. Entire websites exist to monitor the activities of crypto whales and for a good reason. A single whale can have millions of dollars in crypto in a single wallet and has the power to trigger a flash crash.
This would happen if a crypto whale, for example, sold off tens of millions of dollars worth of a token at once. Putting that supply into the market without warning would crash the price of the token and trigger some investors to sell their tokens. But, as we’ve said before, the market would correct itself in the form of new demand. Other investors who want to buy the token at a cheap price would increase demand and drive the value back up. Of course, all this happens within a very short timeframe.
Biggest Flash Crashes
Since flash crashes have been taking place for many years now, there are several examples of them happening. Here are some notable flash crashes:
- The 2010 flash crash. One of the most famous in history, this flash crash took place on May 6, 2010, when a $4.1 billion trade was initiated on the New York Stock Exchange (NYSE). Because of this trade, the Dow Jones Industrial Average Index (DJIA) lost 1,000 points, only to gain them back less than 10 minutes later. The incident lasted about 36 minutes but led to charges against London-based trader Navinder Singh Sarao who had used an algorithm to drive down share prices and buy them for cheap.
- The 2017 Ethereum (ETH) flash crash. In 2017, the crypto exchange Coinbase Inc (NYSE: COIN) saw Ethrerum’s value crashing from around $300 to $0.10 in only a few minutes. This flash crash was triggered by a massive selloff which first brought the price of Ethereum from $317.81 to $224.48. Other traders began selling in response and this caused the flash crash, though the token’s price later recovered.
- The 2016 British pound crash. In 2016, following the UK’s decision to leave the European Union, the British pound briefly fell 6% below the US dollar. This decline lasted only about two minutes and the market price of the pound soon recovered. This crash is believed to be due to an error or an algorithm triggering a massive sell-off.
Bitcoin Flash Crash
Bitcoin (BTC) can also go through a flash crash, following a pattern similar to traditional assets. The price of Bitcoin falls dramatically in a short time and then recovers its losses soon after. What makes Bitcoin flash crash different is the possible reason behind it. Bitcoin flash crashes are usually caused by Bitcoin whales selling off a large amount of their tokens in a short time. After this happens, some smaller traders first sell off their Bitcoin stock in a panic but soon, others buy up the tokens for cheap and the price recovers.
Bitcoin flash crashes can also have immense implications for the crypto exchanges that sell these tokens. It is not unheard of for an exchange to be accused of price manipulation when a flash crash takes place. This is because, during flash crashes, long leverages tend to be sold off and this nets a huge profit for the exchange. For example, during the Ethereum flash crash of 2017 mentioned earlier, Coinbase was accused of market manipulation but proved that it had done nothing wrong.
Preventing a Flash Crash
You might also wonder if it is possible to stop flash crashes from happening and how. To prevent a flash crash, we need to consider the two major reasons that might happen: deliberate sell-offs and technical glitches. In the case of deliberate sell-offs by whales, there is nothing we can do. People are free to sell their assets whenever they want, even if it will cause some commotion in the markets.
When it comes to the second reason, there are a few things we can do to reduce the likelihood, and some of these things have already been done. For example, many major exchanges have circuit breakers that trigger a pause in trading if market indexes fall below a certain rate. A sharp fall below a certain percentage could indicate a technical error and depending on the severity, some exchanges might halt activity for the whole trading day to figure out the issue. The US Securities and Exchange Commission (SEC) has also banned direct access to exchanges in the US to reduce the likelihood of technical glitches affecting market prices.
While flash crashes will still happen at some point, this makes sure that only those triggered by genuine market movements from investors take place.
Flash crashes show the unpredictable nature of asset markets and the power that a handful of investors could have. A single technical error or selloff by a whale could see an entire asset lose a significant chunk of its value, only to gain it back soon after. Flash crashes have existed for years and will continue to happen, with our control over them being limited.
While technological innovations and safeguards mean that glitch-driven flash crashes are less likely, not much can be done if a whale decides to offload a significant amount of assets. As a blink-and-you’ll-miss-it event, flash crashes will continue to impact the market, however briefly, for a long while to come.