Author：BlockBeats
Original title: So what happened on 2/5?
Original author: Jeff Park, Bitwise Consultant
Original translation by: Dingdang, Odaily Planet Daily
Editor's Note: On February 5th, the cryptocurrency market experienced another sharp drop, with over $2.6 billion liquidated in 24 hours. Bitcoin briefly plummeted to $60,000, but the market seems to lack a clear consensus on the causes of this decline. Bitwise consultant Jeff Park...Options and hedging mechanismsFrom this perspective, a new analytical framework has been added.
As time goes on and more data is released, the situation is becoming increasingly clear: this sharp sell-off is very likely related to...Bitcoin ETFThis is relevant, and the day itself was one of the most volatile trading days in the capital markets in recent years. We can reach this conclusion because IBIT's trading volume that day set a new historical high—the turnover exceeded [amount missing].$10 billionThis is the highest record previously.double(Indeed, it's an astonishing number), and options trading volume also broke records (see the chart below for the highest number of contracts for this ETF since its inception). Somewhat unusually, the trading volume structure...This options trading was clearly dominated by put options, rather than call options.(This point will be discussed further later.)
At the same time, we have observed in the past few weeksIBIT's price movement exhibits an extremely strong correlation with software stocks and other risky assets.Goldman Sachs' prime brokerage (PB) team also released a report stating that February 4th was one of the worst single-day performances for multi-strategy funds on record, with a Z-score as high as 3.5. This means it was an extreme event with a probability of only 0.05%, ten times rarer than a 3-sigma event (the classic "black swan" threshold, with a probability of approximately 0.27%). It can be described as a catastrophic shock. Typically, it is precisely after such events that...Risk managers at multi-strategy funds (pod shops) will quickly intervene, requiring all trading teams to immediately, indiscriminately, and urgently deleverage.This explains why February 5th also turned into a bloodbath.
With so many records broken and prices clearly trending downwards (a 13.2% drop in a single day), we initially expected to see a high probability of net redemptions in ETFs. Based on historical data, this assessment wasn't far-fetched: for example, on January 30th, IBIT saw a record $530 million in redemptions after falling 5.8% the previous trading day; or on February 4th, IBIT experienced approximately $370 million in redemptions amidst a continuous decline. Therefore, in the market environment of February 5th, expecting an outflow of at least $500 million to $1 billion was entirely reasonable.
But the truth is quite the opposite—What we saw was widespread net inflows. IBIT added approximately 6 million units that day, resulting in an increase of over $230 million in assets under management. Meanwhile, other Bitcoin ETFs also recorded inflows, with the entire ETF system attracting over $300 million in net inflows in total.
This result is somewhat perplexing. Theoretically, it's plausible to assume that the strong price rebound on February 6th somewhat alleviated redemption pressure, but to directly shift from "potentially reduced outflows" to "net inflows" is entirely different. This implies that multiple factors are likely at play simultaneously, but these factors cannot form a single, linear narrative. Based on the information we currently have, we can propose several reasonable assumptions, upon which I will present my overall deductions.
First, this round of Bitcoin sell-off is very likely...This touches upon a type of multi-asset portfolio or strategy that is not purely crypto-native.This could be either the multi-strategy hedge fund mentioned earlier, or funds similar to BlackRock's model portfolio business that allocate between IBIT and IGV (software ETFs) and are forced to automatically rebalance during periods of high volatility.
Second, the accelerated sell-off of Bitcoin is likely related to the options market, especially options structures that correlate with the downside.
Third, this sell-off did not ultimately translate into an outflow of funds from Bitcoin assets, meaning that the main driving force behind the market movement came from the "paper money system."This refers to position adjustment behavior led by dealers and market makers, and which is generally in a hedging state..
Based on the above facts, my current core assumption is as follows.
1. The direct catalyst for this round of sell-off was a broad deleveraging triggered by the fact that the correlation between the decline in risky assets and the portfolios reached a statistically abnormal level.
2. This process subsequently triggered an extremely aggressive deleveraging, which included Bitcoin exposure, but a significant portion of the risk was actually in "Delta-neutral" hedging positions, such as basis trading, relative value trading (such as Bitcoin relative to crypto stocks), and other structures that are usually "boxed up" by the dealer system to cover the remaining Delta risk.
3. This deleveraging subsequently triggered a short gamma effect, further amplifying downward pressure and forcing traders to sell IBIT. However, due to the intensity of the sell-off, market makers were forced to engage in net shorting of Bitcoin without considering their own inventory. This process, in turn, created new ETF inventory, thereby reducing market expectations of a large-scale capital outflow.
Subsequently, on February 6th, we observed positive capital inflows into IBIT, with some IBIT buyers (the question is, what category do these buyers belong to?).Choose to buy on dips after a decline.This further offset the small net outflow that might have occurred otherwise.
First, I personally tend to believe that this incident...The initial catalyst came from a sell-off in software stocks, especially given the high correlation between Bitcoin and software stocks, even higher than its correlation with gold.Please refer to the two charts below.
This is logically sound, because gold is not typically a major asset held by multi-strategy funds involved in margin trading, although it may appear in RIA model portfolios (a pre-designed asset allocation scheme). Therefore, in my view, this further confirms the following judgment:The epicenter of this round of turmoil is more likely to be within the multi-strategy fund system..
Therefore, the second judgment seems more reasonable, namelyThis aggressive deleveraging process did indeed include the risks associated with Bitcoin, which was being hedged.Taking CME Bitcoin basis trading as an example, this is one of the most favored trading strategies by multi-strategy funds for a long time.
Looking at the complete data from January 26th to yesterday, covering the CME Bitcoin basis trends for 30, 60, 90, and 120-day maturities (thanks to top industry researcher @dlawant for providing the data), it's clear that the near-month basis jumped from 3.3% to a staggering 9% on February 5th. This is one of the largest jumps we've personally observed in the market since the ETF's launch, almost definitively pointing to one conclusion: basis trading was subject to massive forced liquidation under orders.
Imagine institutions like Millennium and Citadel.Forced to close out basis trading positions(Selling spot and buying futures). Considering their size within the Bitcoin ETF system, it's easy to understand why this operation would have such a dramatic impact on the overall market structure. I've previously written down my own analysis on this point.
Editor's Note: The current indiscriminate selling in the US is likely driven by multi-strategy hedge funds. These funds often employ delta hedging strategies or run relative value (RV) or factor-neutral trades, which are currently widening spreads and may also be accompanied by growth stock equity correlation spillovers.
A rough estimate suggests that about one-third of Bitcoin ETFs are held by institutional investors, and of those, approximately 50% (possibly more) are believed to be held by hedge funds. This represents a considerable flow of fast money, which could easily be liquidated in a capitulation if funding costs or margin requirements rise in the current highly volatile environment, especially when risk managers intervene, particularly when the basis gains no longer justify the risk premium. It's worth noting that today's USD trading volume on MSTR is one of its highest in history.
This is why the biggest factor contributing to the collapse of hedge funds is the infamous "co-owner risk": multiple seemingly independent funds holding highly similar exposures, which can lead to a situation where, when the market declines,Everyone rushed towards the same narrow exit at the same timeThis causes all downside correlations to tend towards 1. Selling in the current environment of such poor liquidity is a classic example of "closing off risk," a phenomenon we are seeing today. This will eventually be reflected in ETF fund flow data. If this assumption holds true, I suspect prices will quickly reprice after all this liquidation is complete, but afterwards…Rebuilding confidence will take some time..
This leads to the third clue. Now that we understand why IBIT was sold off amid widespread deleveraging, the question becomes: what exactly is accelerating the decline? One possible "fuel" is structured products. While I don't believe the structured product market is large enough to trigger this sell-off on its own, when all factors align simultaneously and exceptionally perfectly in a way that exceeds the expectations of any VaR (Value at Risk) model, they could very well become an acute event that triggers a chain reaction of liquidations.
This immediately reminded me of my time at Morgan Stanley. There, structured products with knock-in put barriers (options only "activate" into a valid put option when the underlying asset price hits/crosses a specific barrier level) often had extremely destructive consequences. In some cases, the option's delta could even exceed 1, a phenomenon that the Black-Scholes model doesn't even consider—because under the standard Black-Scholes framework, for a typical vanilla option (the most basic European call/put option), the option's delta can never exceed 1.
Take, for example, a note priced by JPMorgan Chase last November, where the knock-in barrier was set at exactly 43.6. If these notes were to continue being issued in December, and the price of Bitcoin were to fall by another 10%, one could imagine a large number of knock-in barriers accumulating in the 38–39 range, which is what is known as the “eye of the storm.”
If these barriers are breached, and traders hedge their knock-in risk by selling put options, then under negative Vanna dynamics, Gamma will change extremely rapidly. At this point, as a trader...The only viable course of action is to aggressively sell the underlying assets when the market weakens.This is exactly what we observed: implied volatility (IV) collapsed to near 90% of its historical extreme, reaching a near-catastrophic squeeze. In this situation, traders had to expand their short positions in IBIT to the point of ultimately creating a net increase in ETF shares. This part does require some extrapolation and is difficult to fully confirm without more detailed spread data, but given the record trading volume that day and the deep involvement of authorized participants (APs), this scenario is entirely possible.
This negative Vanna dynamic becomes clearer when considered in conjunction with another fact. Due to the previously low overall volatility, clients in the crypto-native market have generally favored buying put options in recent weeks. This means that crypto traders are inherently in a short Gamma position and are underestimating potential future excessive volatility in their pricing. When truly significant market movements occur, this structural imbalance further amplifies downward pressure. The position distribution chart below clearly illustrates this, showing that in the $64,000 to $71,000 range, traders are primarily concentrated on short Gamma positions in put options.
This brings us back to February 6th, the day Bitcoin experienced a strong rebound of over 10%. At this point, a noteworthy phenomenon was the significantly faster expansion of CME's open interest (OI) compared to Binance (thanks also to @dlawant for aligning the hourly data to 4 PM ET). From February 4th to 5th, a clear collapse in CME OI was observed, further confirming the assessment that basis trading was massively liquidated on February 5th; on February 6th, these positions may have been re-established to take advantage of higher basis levels, thus offsetting the impact of the outflow.
At this point, the entire logical chain is closed again:IBIT saw relatively flat subscriptions and redemptions as CME basis trading resumed; however, prices remained low due to a significant collapse in Binance's open interest (OI), implying that a substantial portion of the deleveraging pressure stemmed from short Gamma positions and strong parallel trading in the crypto-native market.
This is my best explanation for the market performance on February 5th and the following February 6th. This deduction is based on several assumptions and is not entirely satisfactory because it does not have a clear "culprit" to blame (like the FTX incident). But the core conclusion is this:The trigger for this sell-off came from risk-averse behavior in traditional finance outside of crypto, a process that pushed Bitcoin's price into a range where short-term Gamma hedging would accelerate the decline. This drop wasn't driven by directional bearishness, but rather by hedging demand, and ultimately reversed rapidly on February 6th (unfortunately, this reversal primarily benefited market-neutral funds in traditional finance, rather than native crypto directional strategies).While this conclusion may not be exciting, it at least offers some reassurance: the previous day's sell-off was likely...It has nothing to do with the 10/10 incident.
Yes, I don't believe what happened last week was a continuation of the 10/10 deleveraging process. I read an article suggesting the turmoil might have originated from a non-US, Hong Kong-based fund that participated in a yen carry trade and ultimately failed. But this theory has two obvious flaws. First, I don't believe a non-crypto prime brokerage would be willing to service such a complex multi-asset trade while providing a 90-day margin buffer, and not become insolvent before the risk framework tightened. Second, if the carry trade funds were "escaping" by buying IBIT options, then the Bitcoin price drop itself wouldn't accelerate the risk release—these options would simply become out-of-the-money, their Greek value quickly dropping to zero. This means the trade itself must contain real downside risk. If someone was simultaneously going long on USD/JPY carry trades and selling IBIT put options, then frankly, such a prime brokerage doesn't deserve to exist.
The next few days will be extremely critical, as we will obtain more data.This will help determine whether investors are using this decline to build new demand; if so, it would be a very bullish signal.Currently, I'm quite excited about the potential inflows into ETFs. I remain convinced that true RIA-style ETF buyers (rather than relative value hedge funds) are discerning investors, and at the institutional level, we're seeing significant and substantial progress, evident throughout the industry and among my friends at Bitwise. Therefore, I'm particularly focused on net inflows that aren't accompanied by an expansion in basis trading.
Finally, all of this once again demonstrates that Bitcoin has integrated into the global financial capital markets in an extremely complex and sophisticated manner. This also means that...When the market is on the side of reverse pressure in the future, the upward trend will be steeper than ever before..
The fragility of traditional financial margin rules is precisely the antifragility of Bitcoin. Once the price rebounds—which I believe is inevitable, especially after Nasdaq raised the limit on open interest in options—it will be a truly spectacular move.
