Traders taking excessive risk in the unregulated cryptocurrency market being forced to sell when prices go down were in large part responsible for last week's 30% drop in prices and outages for major exchanges, according to analysts. A burgeoning bitcoin lending market is also adding to the volatility.
The price of cryptocurrencies tanked last week, with bitcoin losing roughly a third of its value in a matter of hours. Bitcoin popped to nearly $40,000 on Monday but is still down about 33% from its high.
When traders use margin, they essentially borrow from their brokerage firm to take a bigger position in bitcoin. If prices go down, they have to pay the brokerage firm back in what's known as a "margin call." As part of that, there's often a set price that triggers selling in order to make sure traders can pay the exchange back.
Brian Kelly, CEO of BKCM, pointed to firms in Asia such as BitMEX allowing 100-to-1 leverage for cryptocurrency trades. Robinhood does not allow traders to use margin for cryptocurrency, and Coinbase only allows it for professional traders.
"You get this crowd factor — everybody's liquidation price tends to be somewhat near everyone else's-- when you hit that, all of these automatic sell orders come in, and the price just cascades down," Kelly, told CNBC.
Bitcoin traders liquidated roughly $12 billion in levered positions last week as the price of the cryptocurrency spiraled, according to bybt.com. This mass exodus wiped out about 800,000 crypto accounts.
"Selling begets more selling until you come to an equilibrium on leverage in the system," said JMP analyst Devin Ryan. That selling begins to "compound" as leveraged positions are liquidated, because they can't meet those margin requirements, he said.