Bitcoin and alternative cryptocurrencies have become largely correlated over the past couple of years. Whenever there’s a serious move in the price of BTC, altcoins are almost always following the lead.
A well-known startup investor and trader, Qiao Wang, took the opportunity to comment on the matter, outlining the reason for this correlation.
Why Bitcoin and Alts Are Correlated?
According to the specialist, the correlation between Bitcoin and alternative cryptocurrencies has a lot to do with the rise of Tether (USDT). In a detailed Twitter thread, Wang offered his take on the matter.
He takes a look back at the “pre-2017 era” when Poloniex was the most dominant altcoin exchange. “Most trading pairs were denominated in BTC. IIRC, there were some USDT-denominated trading pairs on Polo, but the volume was very low.”
To this, he adds that “when Ethereum started trading on Polo back in the day, it was negatively correlated with Bitcoin for several weeks.”
However, as soon as USDT-denominated altcoin trading pairs started to pop, that changed the market microstructure fundamentally, the expert says.
“When a seller dumps millions of dollars of BTCUSD, market makers suddenly become very long. They need to hedge. There are a couple of ways they can do that.” – Wang says.
According to him, the first thing they can do is to sell Bitcoin on other exchanges. However, they can also sell Bitcoin derivatives. Last but not least, they can “simultaneously sell ETHUSD and buy ETHBTC.”
“Why? Because BTCUSD = ETHUSD / ETHBTC. Take a minute to let this sink in. This is the so-called triangle arbitrage.”
He also says that market makers have a lot of options and, in theory, they “don’t have to allocate a ton of capital to sell ETHUSD.” So why would ETHUSD crash as much as BTCUSD? Wang explains that this is because ETHUSD “is far less liquid than BTCUSD. So even a smaller trade can crash ETHUSD more than BTCUSD.”
USDT is Growing, Indeed
USDT, a stablecoin shrouded in controversy as much as one can imagine, has risen to the very top of the ladder. According to CoinMarketCap, it’s currently the third-largest cryptocurrency with a total market cap upwards of $9.1 billion.
Earlier this month, as CryptoPotato reported, USDT transfers to exchanges reached a new all-time high as Bitcoin surged above $10,000.
The importance of USDT grew as more and more cryptocurrency derivatives trading exchanges came into existence, denominating all of their trading pairs in it.