Bitcoin hit by $2.7 billion futures liquidation frenzy: What happens next?

Over $2.7 billion worth of futures contracts were liquidated in the last 24 hours, based on data from Bybt. This caused the price of Bitcoin (BTC) to see a large drop in a short time frame as it plunged from over $41,000 to under $32,600.

Why would mass liquidations cause Bitcoin to drop?

In the futures market, liquidations of positions occur because traders are borrowing additional capital to trade with larger positions.

For example, exchanges in the Bitcoin futures market typically offer up to 100-times leverage. This allows traders to borrow 100 times their initial capital to trade BTC.

The downside of leverage is that when the price of Bitcoin sees a minor drop, it can cause a position to be liquidated, or be worthless.

Liquidated long on XBTUSD: Sell 1,235,411 @ 34710.5 ~ Multi kill ~ If you can dodge a liquidation you can dodge anything

— REKT (@BXRekt) January 11, 2021

For instance, let’s say a trader uses 10-times leverage and borrows 10 times their capital to buy Bitcoin at $40,000. If the price drops 10% to $36,000, the position would be liquidated.

When a long position is liquidated, the position is then sold to the market. Hence, if the majority of the market is longing Bitcoin and long contracts begin to be liquidated, it creates massive selling pressure.

On Jan. 11, the Bitcoin market saw a massive long squeeze triggered by large sell orders on Coinbase. As whales or high-net-worth investors sold, it caused many long contracts to be liquidated in a matter of hours.

The consecutive liquidations led to a domino effect, resulting in a steep sell-off and a 16% correction.

But one optimistic sign is that the correction came to an end at around $32,700, which Whalemap analysts described as a whale cluster support area.

A whale cluster forms when whales buy Bitcoin at a certain level and do not move it. This level often turns into a support area because whales are likely to double down on their entries if a major dip occurs and the price of BTC drops back to that level.

What happens next?

Although Bitcoin saw a large drop, the overall market sentiment around BTC remains generally optimistic.

As Cointelegraph reported, Elias Simos, a protocol specialist at Bison Trails, pinpointed that the number of whales actually increased after Bitcoin saw a big price drop.

The trend shows that whales were actually accumulating as the cascade of liquidations occurred, which is positive. Simos wrote:

“Addresses with more than 1k $BTC continue growing at the expense of all others–even as this most recent downturn is taking effect. While you were selling, whales were gobbling up your Bitcoin.”

Analysts at Glassnode, an on-chain analytics firm, explained that the fundamentals of Bitcoin remain intact despite the drop. They emphasized that the Bitcoin network’s hash rate and mining difficulty are still at all-time highs. The analysts noted:

“While $BTC dipped in value today, on-chain fundamentals remain strong, pointing to a healthy network. #Bitcoin mining difficulty and hash rate are at ATHs.”

While this current 15% to 25% drop is the biggest pullback for this bull cycle to date, it’s worth noting that numerous 30% corrections occurred during Bitcoin’s 2017 bull cycle.

As Cointelegraph reported earlier, the current BTC price pullback coincides with a potential bottom formation of the dollar strength index.