Like all people who follow cryptocurrency, I was surprised to learn that Ethereum went as low as $0.10 on June 21st. In the past few days, there has been a bunch of theories behind the outage as well as GDAX/Coinbase announcing they will refund all traders who lost money in the crash.
Why did the crash happen?
GDAX has experienced multiple outages over the past few weeks and during the flash crash, it was experiencing another outage. This outage is critical to the crash because traders couldn't go into their account and cancel trades. The crash began when a trader put in a market order to sell for 96,100 ETH (~30MM USD). As the order was executed, the price began to fall and with a thin order book, the decline was accelerated. Many traders who were employing margin to trade had their positions liquidated because the value of the account fell below maintenance margin requirements. In "traditional" investment markets such as commodities, a broker will give you at least a business day to increase your collateral back to the initial margin level. This reduces the likelihood of a crash occurring because positions aren't automatically closed. Auto-Liquidation combined with traders being able to change their position caused the drop of Ether on GDAX going from $300+ ETH to $0.10 ETH.
What was the result of this?
Many traders lost and gained a fortune. Some were auto-liquidated out of positions. While one trader purchase 3200 ETH at .10 which resulted in a profit of over $1MM. It remains to be seen what affect this will have on the industry in terms of how margin is handled as well as if exchanges prevent incidents like this occurring through the use of circuit breakers or other preventive measures?
What do I think of Coinbase’s Decision to give a refund to customers?
If I was the Coinbase CEO, I 100% would have made the same decision. This will built a great rapport with a lot of traders who were losing patience with Coinbase after a handle of outages. This will also help stem the tide of negative comments by current customers who have been less than pleased by Coinbase’s customer support.
However, I personally think this sets a very dangerous precedent for the industry. One, many traders will continue to recklessly trade on margin. It’s critical to understand that these aren’t fully developed financial products. Most exchanges are still trying to develop proper KYC/AML requirements and they bear all the risk when it comes to margin trading because they don’t outsource the risk to a third-party.
Second, many will perceive these exchanges as being “safer” because of Coinbase’s decision. Thus, they’ll store more money on it opposed to putting in cold storage. This can lead to major problems especially if an exchange as large as Coinbase fails.
What Coinbase did was the right thing for them, but I am afraid will have unintended consequences as a whole. At the end of the day, cryptocurrencies and crypto assets are financial products that are for the most part unregulated. There should be great caution exercised when investing/trading these types of products. In Forex or equities, you’d never see a broker make a refund under these circumstances. I am afraid that people are being rewarded for recklessness and that never ends well.
Thanks Mo Islam for reading a draft of this.