Bitcoin’s drastic price falls have primarily been associated with unfavorable market news but recent reports suggest that leveraged Bitcoin traders might also be the culprits responsible for the intensity of the dips.

The cryptocurrency market tanked by more than 30% last week on the heels of anti-crypto statements by Chinese regulators and Elon Musk’s unfavorable sentiments on Twitter. Analysts revealed that the intense price drops have to do with the fact that the unregulated market paves way for traders to take on more risk through margin trading. Leveraged Bitcoin traders were forced to exit their positions as the price fell, thus causing a harder crash.

How margin trading works

Leveraged Bitcoin traders use margin trading, which means exchanges allow them to borrow funds to hold larger positions that can increase their potential earnings from each trade. Although margin trading may offer higher returns per trade, it is often considered a double-edged sword because it also causes higher losses. Exchanges can set margin calls that automatically trigger selling at levels that will allow the trader to pay back the exchange in case the price falls.

Many traders had their margin calls triggered during the latest market crash, leading to more liquidation. Exchanges such as BitMex allowed traders to execute trades at 100-to-1 leverage. Bybt.com revealed that roughly $12 billion worth of leveraged positions were liquidated during last week’s bear market. Devin Ryan, an analyst at JP Morgan noted that selling leads to more selling until leverage equilibrium is achieved.

Ryan also added that leverage tends to increase volatility in the crypto markets. He however expects the impact of leverage on the market to be less pronounced in the future thanks to the influx of more institutional money.

Recent events highlight margin trading’s negative impact on crypto gains

Highly leveraged positions make a lot of sense in a bullish market but unfortunately, prices always experience some correction such as what we saw in the last two weeks. It is during such market corrections that leverage becomes toxic for the market because it causes a deeper drop than would have otherwise been the case.

Perhaps the latest bearish performance in the last week would have been less pronounced if it were not for the fact that there were so many highly leveraged positions that were closed, thus triggering more selling. Unfortunately, the fact that the crypto market is not regulated makes it more attractive to investors looking to make a lot of money quickly. Leverage provides an avenue for them to achieve that goal.

Is margin trading bad for the market?

The answer depends on the perspective with which you approach the cryptocurrency market. Every market has forces that determine the price of the underlying asset. If there are forces pushing the price to stratospheric levels, it is only logical that there will be forces that push down prices drastically and this is why margin trading plays an important role in the market.

Those who lost their money due to highly leveraged Bitcoin traders whose Bitcoin holdings were liquidated during the latest crypto crash may have a negative take on margin trading. On the other hand, investors who buy the dip should be pleased by the role of margin trading in creating a pronounced dip. Crypto short-sellers would also have benefitted from the selloff. At the end of the day, money has to exchange hands in the market and market forces determine where it will go.

Margin trading works the same way for other markets including stocks and the forex market. Forced liquidation is the Achilles heel of leverage trading, which explains the high selling volume that was evident in the crypto market in the last week.