The reason for the downward movement of Crypto Assets is the liquidity crisis of market makers? Is the market trend reversing or collapsing?

Recently, the crypto assets market is bleak, and Bitcoin (BTC), which once surged, has been oscillating downwards after reaching a historical high of $126,000, even briefly falling below the important psychological level of $86,000, with a monthly decline of over 20%. The alts are even more desolate, with the market's fear and greed index plummeting to an extreme fear low. Faced with this seemingly endless downward movement, investors are filled with enormous questions: is this a severe but healthy whipsaw in the midst of a bull run, or does it indicate a fundamental reversal of the long-term trend, or even the beginning of a new bear market?

Comprehensive analysis shows that the current weakness in the market is not caused by a single factor, but rather a “perfect storm” woven together by internal structural damage and external macroeconomic pressures.

aftershock of a flash crash

Among numerous analyses, the “market maker liquidity crisis” theory proposed by Tom Lee, chairman of BitMine, reveals the latest perspective on the issue. Tom Lee analyzes that the crux of the current market is not simply a matter of confidence, but rather a “structural short circuit” stemming from the flash crash event on October 11 of this year. On that day, the market experienced an unprecedented large-scale liquidation of over $20 billion. This intense one-sided market not only swept away highly leveraged speculators but also dragged the market makers, who usually serve as the “lubricant” of the market, into the abyss.

Tom Lee compared market makers to the “invisible central bank” of the Crypto Assets market. They provide crucial liquidity to the market through high-frequency buy and sell orders, maintaining the depth of the order book and ensuring smooth transactions. However, the extreme volatility on October 11 caused their risk hedging models to fail instantly, resulting in a massive “financial black hole” on their balance sheets, amounting to as much as 19 to 20 billion dollars.

In order to save themselves and fill the capital gap, these “injured central banks” were forced to take a series of chain actions: Emergency fund recovery: They had to sell off a large amount of their held crypto assets to generate cash flow, which directly constituted the first wave of selling pressure in the market. Shrinking balance sheet: To reduce risk exposure, market makers significantly reduced the number and scale of orders in the market, which is equivalent to actively withdrawing liquidity from the market. Triggering a vicious cycle: When the order book depth sharply shrinks (reports indicate that liquidity once evaporated by 98%), the market becomes extremely fragile. At this point, even small sell-offs are enough to break through several price levels, triggering more forced liquidations of leveraged positions. This “crypto version of quantitative tightening” is entirely an endogenous survival response of the market, leading to a serious decoupling of price trends from the true value of assets, and merely reflecting a temporary failure of market mechanisms.

Tom Lee pointed out that based on similar experiences in 2022, this market recovery process purely triggered by a liquidity crisis usually takes about eight weeks to gradually digest. Currently, it has only been six weeks since the event on October 11, which means the market may still be in the most painful “de-leveraging” and “balance sheet repair” stages, and the continuous weakness in prices is a direct reflection of this process.

The liquidity exhaustion of market makers is also corroborated by other market data. The report from the crypto asset market maker Flow Desk indicates that a large number of “ancient giant whale” wallets, which have been dormant for many years, have recently been activated and have transferred tens of thousands of Bitcoins to centralized exchanges. Against the backdrop of already weak buying pressure due to a lack of liquidity, this sudden massive selling pressure further exacerbates the market imbalance.

In addition, as the end of the year approaches, the mindset of institutional investors has shifted from aggressive offense to conservative defense. To lock in annual profits, fund managers are more inclined to take profits rather than increase risk exposure in an uncertain market, which has made the already thin buyer support even more fragile.

The data from the derivatives market more intuitively reflects the reversal of market sentiment. Data from the Deribit exchange shows that the open interest for the previously most popular $140,000 Bitcoin call options has been surpassed by the $85,000 put options. This indicates that the main betting direction in the market has shifted from anticipating new highs in the bull run to hedging against downward risks, or even directly betting that prices will further fall. Traders are extending the expiration of their put options and lowering the strike price to maintain protection against downward risks, reflecting a general pessimistic outlook.

macroeconomic fog

While the internal structure of the market is damaged, the external macroeconomic environment is also worsening.

Firstly, the latest non-farm payroll data released by the United States far exceeded market expectations. This strong economic indicator acted like a cold shower, extinguishing the market's eager hopes for a rate cut by the Federal Reserve in December. Under the expectation of “higher for longer” interest rates, global risk assets are facing pressure for valuation adjustments, and Bitcoin, as an emerging risk asset, naturally cannot escape this fate.

What is even more interesting and complicated is the signals coming from Japan. The Japanese government recently approved an economic stimulus plan of up to $135 billion, which usually means monetary easing and a depreciation of the yen. In traditional financial theory, a weak yen often encourages “yen carry trades”—where traders borrow yen at low interest rates, convert it into other currencies to invest in high-yield assets. Historically, the prevalence of such trades is often accompanied by an increase in global risk appetite, which is favorable for assets like Bitcoin.

However, this time the situation is different. Japan is facing severe fiscal problems, with its debt-to-GDP ratio reaching 240% and government bond yields soaring to multi-year highs. This means that the depreciation of the yen is no longer just a result of loose policies, but also reflects concerns about the country's creditworthiness. This instability undermines the traditional position of the yen as a reliable financing currency and safe haven. Therefore, the expectation that Japan's stimulus policies can directly boost Bitcoin like in the past may be wishful thinking. The market is in a contradictory position: on one hand, there is the potential for liquidity injection, while on the other hand, there are systemic risks brought about by the instability of the world's second largest arbitrage currency.

A notable phenomenon is that the recent market fall shows obvious regional characteristics. Data shows that the selling pressure of Bitcoin is mainly concentrated during the US trading hours, while the Asian trading hours often see buying pressure, which mitigates some of the decline. The Coinbase premium index has remained negative since November, reflecting the pessimistic sentiment of US institutional investors.

This divergence may stem from different investment logics. American investors may be more focused on macroeconomic data and potential policy risks, tending to reduce risk exposure. In contrast, many Asian investors, especially retail investors, may place greater importance on the long-term value storage narrative of Bitcoin, viewing each significant pullback as a rare “buying opportunity.” This tug-of-war between the East and West results in the market exhibiting a seesaw pattern during the decline.

Conclusion

Considering all the above factors, we can draw a preliminary conclusion: the current downward movement in the crypto assets market resembles a severe internal structural crisis triggered by specific events (the flash crash on 10/11), compounded by deep adjustments caused by unfavorable macroeconomic headwinds.

This is not a typical signal of the end of a bull run and the start of a Bear Market. The core issue in the market lies in the impaired balance sheets of liquidity providers, which has led to a temporary paralysis of trading infrastructure. As long as market makers can gradually repair their capital positions, the market's liquidity “ecosystem” is expected to gradually recover in the coming weeks. Tom Lee's “eight-week recovery period” theory provides an important observation window for the market.

However, investors must never let their guard down. The direction of the Federal Reserve's policies, the evolution of Japan's fiscal situation, and the overall health of the global economy will all be key variables in determining whether the market can regain its upward momentum. Currently, the market is testing the patience of every participant and their ability to distinguish between “signals” and “noise.” Mistaking mechanical failures for fundamental deterioration, or giving up ground in the darkest moments before dawn, could both be costly mistakes.

In the coming weeks, the key to market trends may depend on whether the balance sheets of market makers can successfully “heal” and whether there will be new turning points at the macroeconomic level. For investors, prudent allocation, strict risk control, and closely monitoring changes in liquidity indicators will be the winning strategy to navigate through this storm.

#Bitcoin Volatility