Bitcoin plunged earlier this month to nearly $60,000, erasing large amounts of value in the crypto market and vaporizing some trading funds.
Most observers attributed the decline to macroeconomic forces, including the capitulation of cash ETF holders (and possible rumors that the funds had blown their positions). Another, quieter force that generally keeps trade running smoothly likely played a major role in the spot price fall.
This force is the market makers, or traders, who continually post buy and sell orders to the order book as you trade, maintaining strong liquidity so that trades run smoothly without delays or significant price increases. They always stand on the opposite side of investors’ trades and make money through the bid-ask spread, the small gap between the buying (bid) price and the selling (ask) price of an asset, without betting on whether prices will rise or fall.
They hedge their exposure to price volatility by buying and selling real assets (such as bitcoin) or related derivatives. And sometimes, these hedging activities end up accelerating the movement in progress.
This is what happened between February 4 and 7, when bitcoin rose from $77,000 to almost $60,000, according to Markus Thielen, founder of 10x Research.
This episode shows that the Bitcoin options market increasingly influences its spot price, like traditional markets where market makers discreetly amplify volatility.
According to Thielen, options market makers were “short gamma” between $60,000 and $75,000, meaning they held bags of short options (call or put) at those levels without enough hedges or protective bets. This made them vulnerable to price volatility around these levels.
When bitcoin fell below $75,000, these market makers sold BTC in the spot or futures markets to rebalance their hedges and remain price neutral, thereby injecting additional selling pressure into the market.
“The presence of approximately $1.5 billion of negative gamma options between $75,000 and $60,000 played a critical role in accelerating Bitcoin’s decline and helps explain why the market rebounded strongly once the last large gamma cluster near $60,000 was triggered and absorbed,” Thielen said in a note to clients Friday.
“Negative gamma means that options traders, who are typically the counterparties to investors who buy options, are forced to hedge in the same direction as the underlying price moves. In this case, as Bitcoin fell into the $60,000-$75,000 range, traders became increasingly short gamma, forcing them to sell bitcoin as prices fell to stay covered,” he explained.
In other words, coverage by market makers established a self-reinforcing cycle of falling prices, forcing dealers to sell more, which further drove prices down.
Note that market maker coverage is not always bearish. At the end of 2023, it was also short options above $36,000. As the Bitcoin spot price rose above this level, they bought BTC to rebalance it, sparking a rapid rally above $40,000.
