here is a precise, technical explanation of yesterday's crash and why it is HEALTHY: think of futures/perps market as a basket of loans. leverage = borrowing money naturally, each loan has a probability of default, and the basket is priced based on both P(default), but also the correlation between defaults on each loan (likelyhood we get more defaults if a loan defaults) lenders have an incentive to underestimate the correlation between defaults. because it allows to price their basket higher and keep selling it. exchanges show collateral, reserves and can attract more traders. the problem is loans are much more correlated than their price shows. the timing of the cascade is random, and needs a trigger like trump tariffs on china. but what happens after that is coded: > price goes down > triggers first liquidation/loan defaults > price goes down > etc 1 default = 1 more default. defaults are correlated. so, although lots of ppl lost money, the whole system would have lost a lot MORE in another, worse scenario the other worse scenario is basically the 2008 crisis. the system was contaminated with overpriced mortgage loans b/c banks/insurances (often intentionally) underestimated correlation between defaults when a house went for sale after default, it affected prices of surrounding areas (more supply), which triggered more defaults etc all defaults lead to volatility, but volatility is not linear. a 50% market crash is much worse than 5 10% crashes. this non linearity explains why crypto is stronger than tradfi. in crypto, we get a chance to learn from these crashes often and improve the system for the better in tradfi, crashes happen less often, but when they do, they have a much much larger impact b/c they've infected the whole system
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dashboards showed 50% arbs between exchanges yesterday, but theyr not always real retail is not equipped to take advantage of arbs during crashes. why? bc u need sophisticated ops and execution infra. what ur not thinking of is: > interexchange transfer delays > gas fees > spreads and market impact > speed/latency basically u cant just sign up to all these exchanges in 2 minutes, trade and make money. u need to be operationally ready and have trading infra ready and aligned to execute fast, accurately and in good enough size to make $ post tx costs only experts/firms have this. if u r retail and made money with arbs yesterday id love to hear from u
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Why do these crashes happen in crypto? They are a side effect of regulations and systemic risk profile > less regulations = more innovation = outsized returns > less regulations = less regulated exchanges = more crashes Its a healthy feature, not a bug. And it will keep happening b/c of incentives: 1. Exchanges are happy providing leverage and making fees. very lucrative biz. A deltra-neutral market-making book's biggest days are often these crashes. high volume, high fees. 2. Ppl in crypto like to gamble so there is product market fit. There is demand for leverage. Based on Nassim Taleb's ideas, my thinking is: > In crypto, crashes happen more often than TradFi as part of "natural evolution" where only the best survive. No central bank to subsidize otherwise dead projects. This makes cryptomarkets Antifragile as we all get used to these crashes and learn to survive. > In TradFi, CBs and govs do their max to reduce volatility with QE, rates etc. They 'subsidize' otherwise dead companies that take more time to crash. Less crashes, bu higher magnitudes, it makes the system Fragile So crashes aren't always unhealthy and the benefits can outweight the cost. Benefits are the outsized returns we get in crypto, and the cost is this regular short-term vol. Really depends how you look at Risk also. A system can can survive 5 crashes of 20%, and learn from each crash. But it cannot survive 1 single 100% crash. So volatility isn't always bad if it reduces Tail Risk, which u don't get really get to recover from.
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