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Crypto Market Cycles: What Causes Markets to Rise and Fall
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2025-01-13 13:02 1,611

Crypto Market Cycles: What Causes Markets to Rise and Fall

Author: Tulip King; Compiled by: Block unicorn

Foreword:

The abhorrent behavior of @BanklessVC clearly demonstrates that we have entered a predatory, PvP (player versus player) market phase. Protect yourself and your profits.

I suspect this cycle has peaked and is now experiencing a natural pullback as the crypto market attempts to release pain - but that pain may linger for some time.

Coins like virtuals, ai16z, and heyanon may hit new all-time highs in the recovery, but they are subject to narrative risk—continue to reevaluate your worldview.

What drives the market?

It is obvious that the reason why the market rises is because of new money flowing into the market. From now on, I will discuss the concept of new money flowing into the market in relation to the "wealth effect". We should all want the crypto industry to create real value (wealth) in the world and share in the fruits of monetary expansion. This can be achieved in the following ways:

1. Wealth creation through innovation (airdrop)

Airdrop has become a powerful mechanism for value redistribution in the crypto market, creating a significant wealth effect and enabling a wide range of Participants benefit. The September 2020 Uniswap airdrop set the standard, distributing 400 UNI tokens (worth approximately $1,400 at launch) to over 250,000 addresses, with an eventual total value of over $900 million.

Jito airdrop was an important catalyst in the early bull market of Solana altcoins

The Jito airdrop in December 2023 distributed 90 million JTO tokens coins, with a total value of $165 million, and some users have reaped rewards of up to $10,000 just by transferring $40 worth of JitoSOL. The Jito airdrop helped drive growth in Solana’s total value locked (TVL) and fueled increased on-chain activity. This wealth effect spurs adoption and growth of the broader Solana ecosystem, similar to how Uniswap’s UNI token catalyzed DeFi growth.

Jupiter’s token distribution method further demonstrates the democratizing potential of airdrops. They plan to distribute 700 million JUP tokens to over 2.3 million eligible wallets, making it one of the most widely distributed airdrops in crypto history. Jupiter’s airdrop strategy aims to promote the growth of its ecosystem by incentivizing long-term participation and governance participation. These airdrops have shown remarkable efficiency in expanding market participation.

That’s what I’m saying

The wealth effects are not limited to direct financial gains. These airdrops have turned users into stakeholders, allowing them to participate in governance and protocol development. This This mechanism creates a virtuous cycle: Beneficial participants invest wealth back into the ecosystem, further driving market expansion and innovation.

These strategic distributions have proven to be powerful market catalysts, sparking innovation in their respective fields. Uniswap’s airdrop ignited 2020’s broader bull cycle. Likewise, Jito’s airdrop in December 2023 served as a turning point for the Solana ecosystem, driving TVL. Growth and catalyzing unprecedented on-chain activity. This surge in liquidity and market confidence set the stage for the subsequent altcoin explosion and led to significant growth. These airdrops actually acted as an economic stimulus for the entire ecosystem. , creating self-reinforcing cycles of investment and innovation that define their respective market eras

2. Appreciation of Wealth (Marginal Buyers)

When the market experiences a positive catalyst like a strategic airdrop, it attracts players who were previously on the sidelines, bringing new capital and enthusiasm to these marginal buyers. The influx creates a virtuous cycle of market expansion and innovation

Airdrops trigger positive trends. FOMO, driving new and old users to participate more deeply in the market

After witnessing the successful airdrop and subsequent market momentum, investors on the sidelines began to deploy capital and transformed from bystanders to active market participants. This shift from cash to cryptoassets represents genuine new money entering the ecosystem, not just transfers between existing players

Large financial institutions are increasingly driving this shift, including Companies such as BlackRock, Fidelity, and Franklin Templeton are creating new ways to combine traditional finance with digital products that connect digital assets. Their participation helps legitimize the market and provide easier access for sideline funds to enter the market. This expansion creates a positive-sum environment where new players contribute to overall market growth. .

Unlike a zero-sum trading environment, markets inspired by new players create a real wealth effect by expanding liquidity, increasing development activity, and expanding adoption. More wait-and-see capital will further promote the growth of the ecosystem.

3. Wealth Creation through Leverage (Multiple Expansion)

At the end of the bull market, leverage becomes the main driver of price increases, marking the transition from value creation to value multiplication when traders increasingly enter the price discovery stage. Use leverage to amplify positions, creating a self-reinforcing upward momentum cycle

When Bitcoin enters a phase of price discovery above all-time highs, the leverage ratio will increase.A sharp rise as traders seek to maximize their risk exposure. This has a knock-on effect, where borrowed stablecoins drive further purchases, driving up prices and encouraging more leveraged positions. This multiplier effect accelerates price movements.

The increasing leverage has also brought systemic vulnerabilities to the market. As more traders take leveraged positions, the likelihood of cascading liquidations increases, especially as borrowed stablecoins become more expensive and difficult to obtain.

The rise in stablecoin borrowing costs is a key indicator that the market is entering its final stages. This represents a critical shift from organic growth to leverage-driven expansion, where no new value is created - just existing value is amplified through debt.

The heavy reliance on leverage at this stage creates an unstable situation, where sudden price fluctuations can trigger large-scale liquidations and lead to rapid price corrections. This fragility signals that the bull market is coming to an end, as the system becomes increasingly reliant on borrowed funds rather than underlying value creation.

What caused the market to fall?

It is also obvious that the market fell because funds were flowing out of the market. This is essentially the reverse wealth effect, where speculators take advantage of the animal spirits of the market, with smart money taking chips off the table to lock in profits, and the dumb ones being liquidated.

1. Wealth is extracted from the market

The crypto ecosystem regularly goes through cycles of value extraction, in which savvy operators devise schemes to extract capital from enthusiastic market participants. Rather than productive innovations that distribute value, these schemes systematically remove liquidity from the market through a variety of predatory mechanisms.

The most disgusting part of the Bankless story is that they only spent 2 SOL and drained thousands of SOL from the ecosystem

The recent Aiccelerate DAO launch illustrates this evolution - despite being backed by high-profile advisors like Bankless founders and industry veterans, the project began selling off after insiders received the tokens without a lock-up period , the project was immediately criticized. Even big names can become vehicles for rapid value extraction.

Celebrity tokens also reflect this predatory behavior. These projects kill the altcoin cycle by effectively transferring wealth from retail buyers to insiders through malicious smart contracts and coordinated dumping. These withdrawal incidents undermine market confidence and disincentivize legitimate participants. Rather than building a sustainable ecosystem, they create cycles of distrust that undermine the maturity of the broader cryptocurrency ecosystem.

I have discussed this issue before in the Messari newsletter

Instead of reinvesting profits into ecosystem development, these schemes sexually withdrawn from the marketGet liquidity. Withdrawn funds often exit the crypto ecosystem entirely, reducing the total capital available for legitimate projects and innovations.

The evolution from obvious scams to sophisticated operations backed by high-profile individuals represents a worrying trend. When established institutions engage in rapid value extraction, it becomes increasingly difficult for market participants to differentiate between legitimate projects and sophisticated fraud.

2. Only sellers

Are you surprised that BAYC reached the top after just 3 months?

When the market starts to fall, a key asymmetry emerges - the gap between mature players who are aware of the market changes and retail investors who still believe in the bullish thesis. At this stage, the market is not characterized by the entry of new capital, but by the planned extraction of liquidity by experienced traders.

Professional traders and investment firms began to reduce risk exposure while maintaining public optimism. Venture capital firms quietly liquidate positions through OTC markets and strategic exits, protecting capital while avoiding market impact. This approach creates an illusion of stability even as large amounts of capital have exited the system.

Smart investors began to withdraw liquidity from DeFi protocols and trading venues. This subtle but steady flow of liquidity creates increasingly fragile market conditions, although its effects are not immediately visible to the casual observer.

Looks like some smart investors are taking chips off the table

Denial: While profits can be made by experienced players, Retail investors often still believe that declines are temporary buying opportunities. This cognitive dissonance is reinforced by:

The information cocoon of social media maintains a bullish narrative

Attachment to bull market unrealized gains

Misinterpretation of the mentality of "diamond hands"

Most retail investors miss the best exit point, still hold on to the initial decline, and try to justify their decisions. By the time a downward trend becomes apparent, a significant amount of value has been lost, panic has increased, and selling pressure has intensified.

The steady withdrawal of professional capital has created deteriorating market conditions, with each subsequent sell order having an increasingly pronounced impact on prices. Deteriorations in market depth often go unnoticed until large price movements expose underlying vulnerabilities.

Unlike the positive-sum environment driven by new entrants in a bull market, this phase represents pure value destruction as capital systematically exits the crypto ecosystem and remaining participants have to endure ever-increasing losses.

3. Leverage explosion (liquidation chain reaction)

The final stage of market capitulation reveals the devastating effects of excessive leverage, as Warren Buffett famously said: "Only when the tide goes out will you Discover Who’s Swimming Naked “The most dramatic crashes in crypto markets have been driven by this.A clear manifestation of the principle.

The unraveling began in June 2022 with the collapse of 3AC’s $10 billion hedge fund. Their leveraged positions, including $200 million in LUNA and substantial exposure to the Grayscale Bitcoin Trust, triggered a series of forced liquidations. The fund's failure revealed a tangled web of interconnected loans, with more than 20 institutions affected by its default.

FTX’s collapse further illustrates the dangers of hidden leverage. Alameda Research borrowed $10 billion of FTX client funds, creating an unsustainable leverage structure that ultimately led to the collapse of both institutions. Disclosures revealed that 40% of Alameda’s $14.6 billion in assets were held in illiquid FTT tokens, exposing the vulnerability of their leveraged position.

Old research by @Saypien_

These crashes triggered widespread market contagion effects. 3AC’s collapse led to the bankruptcy of several cryptocurrency lenders, including BlockFi, Voyager, and Celsius. Likewise, FTX’s collapse had a domino effect across the industry, with many platforms freezing withdrawals and eventually filing for bankruptcy.

Continuous liquidations reveal the true face of market depth. When leveraged positions are forcibly liquidated, asset prices plummet, triggering further liquidations, creating a vicious cycle. This exposes how much of the market's apparent stability is underpinned by leverage rather than true liquidity.

The receding tide revealed that many institutions thought to be mature were actually swimming naked, with inadequate risk management and excessive leverage. The interconnected nature of these positions means that a failure could trigger a system-wide crisis, exposing the vulnerability of the entire crypto ecosystem.

Looking Ahead - Narrative Risks

The title of this article is a bit provocative. My gut tells me this is just a healthy, albeit painful, market shake-up. We will bounce back. Price targets for Bitcoin in particular remain quite high - but I've taken the chips off the table and locked in Bitcoin gains that I'd be willing to carry into the next cycle, if this is indeed the end. Remember, no one goes bankrupt because of profits.

I have written many times about the importance of following the market narrative and not sticking to old coins. The longer this market remains down, the more the narrative will change. If the market fully recovers tomorrow morning, I expect virtuals, ai16z, and virtuals-based tokens to continue to win. But if the market recovery takes longer, then you should keep an eye on emerging coins to see if they can attract new inflows.

You should understand that I am telling you not to have a currency holding bias unless you really have a firm belief.You must have a certain belief, otherwise don't hold your currency until the downturn. Even if they make new all-time highs, I bet you're missing out on a lot of potential gains by not converting to new coins in a timely manner.

The only reason people post Fibonacci charts is to convince themselves (and others) that they can sell at a higher price.

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Keywords: Bitcoin
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