Cryptocurrencies are risky as hell. A new competitor in the blockchain currency world, Ethereum, has recieved a lot of attention recently for its ridiculous gains in value. Many feared that a flash crash last week was a sign of shady dealings on the exchange, but the company behind it is reassuring investors that they will be paid back in full.
Among the many reasons that investors should be worried about investing in crypto-assets like Bitcoin and Ether is the potential for an exchange to just disappear with your money. So when the Ethereum exchange GDAX experienced a flash crash last week, investors were right to be alarmed. For one brief moment, the cryptocurrency plunged from a value of $US320 ($423) a piece to about $US0.10 ($0). It quickly recovered, but for some investors, the damage was done.
The flash crash was the result of someone placing a multi-million-dollar sell order at market price, meaning ETH would change hands at whatever price bidders were currently offering until the entire order was filled -- no matter how much lower the price was than the current price of ETH.
Filling this order caused ETH prices to instantly slip 30% to $US224 ($296) -- which in turn caused 800 stop loss orders and margin liquidations, which further drove the price down, to as low at $US0.10 ($0).
A stop loss order is a limit that a trader puts on how low the price can go before they sell. A trader might have set the lowest price he's willing to accept to $US50 ($66), and when the price plunges past that point, all of that investor's assets are automatically sold off. Margin funding liquidation works in much the same way. An investor has borrowed money to put into the market, and if the asset drops to a predetermined price, it's sold off to repay lenders.
Coinbase, the parent company that runs GDAX says that it will dip into its company funds to credit customers who were harmed by the flash crash. That's good for those investors but the real winners in this situation are the people who managed to buy Ether (Ethereum is the blockchain, Ether is the asset) at such an incredibly low price. Currently, the price has mostly recovered to $US317.04 ($419).
This doesn't necessarily mean that GDAX is great and trustworthy. They have been on an incredible run for months now (up 4,100 per cent year-to-date) and the last thing they need is a loss of confidence from investors. Coin offerings can go for years before everyone involved gets royally screwed.
Also, don't expect this to be the last time something similar happens with Ether. GDAX is educating users about spacing out large trades so that crashes can be avoided, but that doesn't mean they will necessarily care. One big reason that cryptocurrencies have exponentially jumped in price is Japan's decision to start regulating bitcoin exchanges. Investors on Wall Street are also jumping into the game. This makes things feel more legitimate, but it's still a very shady world. Analysts have also attributed the price gains to companies stockpiling cryptocoins to have on hand in case they need to pay a ransom.
The volatility in this business is likely to continue for a long time, if not forever. Unfortunately, that volatility could spill over into traditional markets. Analysts have noticed that Bitcoin mining has been driving up the value of GPU makers Nvidia and AMD. A sudden investor withdrawal in mining operations could destabilize those companies' stocks.