Original Title: Local Tops: what makes the market go up and down
Original Author: mikeykremer, Chief Technology Officer at MessariCrypto
Original Translation: zhouzhou, BlockBeats
The following is the original content (reorganized for better readability):
Alpha debut: The disgusting behavior of BanklessVC clearly indicates that we have entered the "extractive PvP phase" of the market, so protect yourself and your profits. I suspect this cycle has peaked; it is just a natural adjustment reflecting the crypto market's search for pain points to extract from, although these pain points may persist for a while.
Tokens like Virtuals, ai16z, and heyanon may create new highs during the recovery period, but they also face narrative risks, so continuously reassess your market views.
Why does the market go up?
The market rises because new capital enters the market, which is obvious. From now on, I will use the concept of "wealth effect" to describe the process of new capital entering the market. We all hope that cryptocurrencies can create real value in the world and allow us to share in this growth through monetary expansion. Here are several ways to achieve this goal:
1. Creating wealth through innovation (Airdrops)
Airdrops have become a powerful value redistribution mechanism in the crypto market, capable of generating significant wealth effects that benefit a wide range of participants. For example, the Uniswap airdrop in September 2020 set the industry standard by distributing 400 UNI tokens (worth about $1,400 at issuance) to over 250,000 addresses, with a total value ultimately exceeding $900 million.
The Jito airdrop in December 2023 was an early catalyst for the Solana meme coin bull market.
The Jito airdrop distributed 90 million JTO tokens, valued at $165 million at issuance, with some users receiving rewards of up to $10,000 just by transferring JitoSOL worth $40. The Jito airdrop drove an increase in Solana's total locked value and boosted on-chain activity. This wealth effect facilitated broader adoption and development of the Solana ecosystem, just as Uniswap's UNI token catalyzed the growth of DeFi.
Jupiter's token distribution method further exemplifies the inclusive potential of airdrops. They plan to distribute 700 million JUP tokens, covering over 2.3 million eligible wallets, making it one of the most widely distributed airdrops in crypto history. Jupiter's airdrop strategy aims to expand its ecosystem by incentivizing long-term participation and governance involvement. These airdrops have demonstrated extraordinary efficiency in expanding market participation.
The wealth effect is not limited to direct economic benefits; these airdrops transform users into stakeholders, enabling them to participate in governance and protocol development. This transformation creates a virtuous cycle where benefiting participants reinvest their wealth into the ecosystem, further driving market expansion and innovation.
These strategic distributions have proven to be powerful market catalysts, triggering broader bull market cycles in their respective fields. For example, Uniswap's airdrop ignited the DeFi summer of 2020, with its distribution driving a wave of innovation in decentralized finance. Similarly, the Jito airdrop in December 2023 became a turning point for the Solana ecosystem, driving TVL growth and triggering unprecedented on-chain activity.
This surge in liquidity and market confidence laid the groundwork for the subsequent meme coin explosion, resulting in significant market growth. These airdrops effectively acted as stimulus programs covering the entire ecosystem, creating a self-reinforcing cycle of investment and innovation that defined the era characteristics of their respective markets.
Wealth accumulation (Marginal buyers)
When positive catalysts like strategic airdrops occur, they attract previously hesitant participants to enter the market with new capital and enthusiasm. The influx of these marginal buyers creates a virtuous cycle of market expansion and innovation.
Airdrops stimulate significant positive FOMO, driving both new and existing users to engage more deeply in the market.
Previously hesitant investors begin to deploy capital after witnessing successful airdrops and the subsequent market momentum, transitioning from bystanders to active participants. This shift from cash to crypto assets represents a true influx of new capital into the ecosystem, rather than a simple transfer among existing participants.
Large financial institutions are increasingly facilitating this transition. Companies like BlackRock, Fidelity, and Franklin Templeton have launched products that connect traditional finance with digital assets. The participation of these institutions helps legitimize the market and provides a more convenient entry point for hesitant capital. This expansion creates a positive-sum environment where new participants contribute to overall market growth.
Unlike a zero-sum trading environment, a market active with new participants creates real wealth effects through liquidity expansion, increased development activity, and broader adoption. This positive feedback loop attracts more hesitant capital, further driving ecosystem growth.
3. Creating wealth through leverage (Multiplicative expansion)
In the terminal phase of a bull market, leverage becomes the primary driver of price increases, marking a shift from value creation to value multiplication. As the market enters the price discovery phase, traders increasingly use leverage to amplify positions, forming a self-reinforcing cycle of upward momentum.
When Bitcoin enters the price discovery phase above historical highs, leverage ratios significantly expand as traders attempt to maximize their exposure. This triggers a chain reaction where borrowed stablecoins drive further purchases, raising prices and encouraging more leveraged positions. This multiplicative effect accelerates price volatility.
The increasing prevalence of leverage also introduces systemic vulnerabilities to the market. As more traders adopt leveraged positions, the likelihood of cascading liquidations increases, especially when borrowing stablecoins becomes more expensive and difficult to obtain.
The rising cost of stablecoin borrowing is a key indicator that the market is entering its final phase, marking a transition from organic growth to leverage-driven expansion, at which point the market is no longer creating new value but merely multiplying existing value through debt.
At this stage, the high dependence on leverage places the market in a precarious position, where sudden price fluctuations can trigger large-scale liquidations, leading to rapid price corrections. This vulnerability indicates that the bull market is nearing its end, as the market increasingly relies on borrowed funds rather than fundamental value creation.
What makes the market go down?
When capital flows out of the market, the market goes down, which is evident. This is essentially a reversal of the wealth effect, where speculators exploit market sentiment, smart money withdraws to lock in profits, while foolish money suffers from liquidations.
Wealth is extracted from the market, and you are experiencing this phase
The crypto ecosystem often undergoes cycles of value extraction, where savvy operators design various strategies to siphon funds from enthusiastic market participants. Unlike innovations that distribute value, these strategies systematically withdraw liquidity from the market through various predatory mechanisms.
The most disgusting aspect of the Bankless story is that they extracted thousands of SOL from the ecosystem with just 2 SOL.
The recent launch of Aiccelerate DAO further showcases the evolution of this phenomenon. Despite the support of well-known advisors like Bankless founders and industry veterans, the project faced criticism upon launch as insiders began selling tokens without a lock-up period. Even well-known projects can become tools for rapid value extraction.
Star tokens are also typical examples of this predatory behavior, where these projects transfer wealth from retail buyers to insiders through malicious smart contracts and organized sell-offs, ending the bull market cycle for meme coins. Such value extraction events severely undermine market confidence and hinder the entry of compliant participants.
These actions not only fail to establish a sustainable ecosystem but also create a cycle of distrust that hampers the mature development of the entire cryptocurrency ecosystem.
Rather than reinvesting profits into the development of the ecosystem, these schemes systematically withdraw liquidity from the market. The extracted funds often flow completely out of the crypto ecosystem, reducing the total available capital for legitimate projects and innovation.
From obvious scams to complex operations supported by well-known institutions, this trend is concerning. When well-known institutions participate in rapid value extraction, it becomes increasingly difficult for market participants to distinguish between legitimate projects and complex scams.
2. Only sellers
Is it surprising that BAYC peaked after 3 months?
When the market begins to decline, a clear asymmetry emerges between seasoned players and retail participants. The former can quickly sense a market turn, while the latter remains immersed in optimistic narratives. This phase is characterized not by the inflow of new capital but by the orderly withdrawal of liquidity by experienced operators.
Professional traders and investment firms maintain an outwardly optimistic stance while reducing their exposure. Venture capital firms quietly cash out through over-the-counter trades and strategic exits, preserving capital without impacting the market. This operation creates an illusion of market stability, even as significant amounts of capital have quietly exited the system.
"Smart money" has also begun to withdraw liquidity from DeFi protocols and trading platforms. This subtle yet persistent capital withdrawal is making market conditions increasingly fragile, although this impact may not be immediately apparent to the average observer.
It seems that some smart money is exiting the market, reflecting the psychology of denial: while seasoned players secure profits, retail investors often still believe that the downturn is merely a temporary buying opportunity.
This cognitive dissonance is reinforced in the following ways:
- Social media echo chambers maintain an optimistic narrative
- Reliance on unrealized gains during the bull market
- Misinterpretation of the "diamond hands" mentality
Most retail investors miss the best exit opportunities, often holding on during initial declines, trying to justify their decisions. As the downtrend becomes apparent, much value has already been lost, and with the spread of panic, selling pressure intensifies.
The continued withdrawal of professional capital has led to deteriorating market conditions, with each subsequent sell order having an increasingly noticeable impact on prices. This deterioration in market depth often goes unnoticed until significant price volatility exposes systemic vulnerabilities.
Unlike the positive-sum environment of new capital entering during a bull market, this phase represents pure value destruction, with capital systematically exiting the crypto ecosystem, leaving remaining participants to bear increasingly severe losses.
Leverage Explosion (Chain Reaction of Liquidations)
The final stage of market capitulation reveals the devastating effects of excessive leverage, as Warren Buffett famously said, "Only when the tide goes out do you discover who's been swimming naked." The most severe crashes in the crypto market clearly illustrate this principle.
This crash began in June 2022 with the bankruptcy of the $10 billion hedge fund 3AC. Their leveraged positions, including $200 million in LUNA and significant exposure to the Grayscale Bitcoin Trust, triggered a chain reaction of forced liquidations. The fund's failure exposed a complex web of interrelated loans, affecting over 20 institutions.
The collapse of FTX further highlighted the dangers of hidden leverage. Alameda Research borrowed $10 billion from FTX customers, creating an unsustainable leverage structure that ultimately led to the downfall of both institutions. It was revealed that 40% of Alameda's $14.6 billion in assets was locked in illiquid FTT tokens, further exposing the fragility of its leveraged positions.
This crash triggered widespread market contagion. The collapse of 3AC led to the bankruptcy of several cryptocurrency lending platforms, including BlockFi, Voyager, and Celsius. Similarly, the collapse of FTX initiated a domino effect within the industry, causing many platforms to freeze withdrawals and ultimately file for bankruptcy.
The chain of liquidations revealed the true state of market depth. As leveraged positions were forcibly closed, asset prices plummeted, triggering further liquidations and creating a vicious cycle. This exposed that the apparent stability of the market relied more on leverage than on genuine liquidity.
When the tide goes out, it reveals that many institutions that thought themselves savvy were actually swimming naked, lacking proper risk management and over-leveraged. The interconnectedness of these positions means that once one fails, it can trigger a systemic crisis, exposing the vulnerabilities of the entire crypto ecosystem.
Looking Ahead - Narrative Risks
The title of this article is somewhat provocative. My intuition tells me that this market adjustment is healthy; although a bit painful, the market will rebound. My price targets, especially for Bitcoin, remain high—but I have already pulled my chips off the table and locked in the Bitcoin profits I am willing to carry into the next cycle. If this truly is the end of the cycle, remember: no one goes bankrupt for taking profits.
I have written multiple times (Article 1, Article 2, and Article 3) about the importance of following market narratives and avoiding being trapped by old coins. The longer the market downturn lasts, the more the narrative will change. If the market fully rebounds tomorrow morning, I expect virtual coins, ai16z, and meme coins to continue leading. But if the market recovery takes longer, you should focus on emerging coins that aim to attract new capital's attention.
What I want to tell you is to avoid bias towards the coins you hold and do not insist on holding them through these downturns (unless you truly have strong conviction). Even if they reach new highs, I bet you will lose a lot of potential gains by not timely switching to new coins.
The only reason anyone posts Fibonacci charts is to convince themselves (and others) that they can sell at higher prices.
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