Wall Street mogul Tom Lee: The adjustment in the crypto market may be nearing its end, and Bitcoin is becoming a leading indicator for U.S. stocks

Wall Street veteran strategist Tom Lee believes that the persistently weak cryptocurrency market since October 10 may soon complete its adjustment, pointing out that Bitcoin and Ethereum have become leading indicators for U.S. stocks. This judgment is based on the balance sheet repair cycle of cryptocurrency market makers after suffering heavy losses during the massive liquidation event in 2022.

On November 21, Tom Lee, chairman of BitMine and former chief equity strategist at JP Morgan, stated in an interview with CNBC that the massive liquidation event on October 10 "severely weakened market makers," who play a key liquidity provider role in the cryptocurrency market that is "almost equivalent to a central bank."

(Source: CNBC)

This Wall Street veteran compared the current situation to the 2022 cryptocurrency market liquidation. He noted that similar events in 2022 took eight weeks to fully digest, while only six weeks have passed this time. This indicates that the market is still in a state of impaired liquidity and reflexive weakness.

He also pointed out that during recent market fluctuations, Bitcoin often declines ahead of the stock market, reflecting the warning effect of tight liquidity in the cryptocurrency market on traditional markets. Tom Lee specifically mentioned that on October 10, Bitcoin turned before the U.S. stock market fell, confirming the leading nature of cryptocurrencies over the stock market.

Since October 10, the price of Bitcoin has plummeted, dropping from a high of $125,000 in early October to around $82,000 currently.

October Liquidation Event Devastates Market Makers

Tom Lee elaborated on the market shock event of October 10. On that day, the price of a stablecoin within an exchange experienced abnormal fluctuations, dropping from the expected $1 to $0.65.

This price deviation occurred only within that exchange but triggered an automatic liquidation mechanism known as ADL (Automatic D liquidation). This automated process is similar to margin calls, where liquidation is automatically executed when the price of an account or collateral falls.

Due to the cascading effect of liquidations across exchanges, approximately 2 million cryptocurrency accounts were liquidated, even though these accounts were still profitable just minutes before.

Tom Lee attributed the root cause of this event to a "code error." He pointed out that the exchange relied on internal quotes rather than cross-exchange pricing to set the stablecoin price, a design flaw that led to systemic risk.

This liquidation caused significant capital losses for market makers, forcing them to shrink their balance sheets.

Vicious Cycle of Liquidity Exhaustion

After the capital of market makers was impaired, the market fell into a cycle of reflexive weakness.

Tom Lee emphasized that market makers provide critical liquidity in the cryptocurrency market, and their role is "almost equivalent to a central bank for cryptocurrencies." When their balance sheets have gaps that need to be filled with capital, they must reflexively reduce their balance sheets and decrease trading As cryptocurrency prices decline, market makers require more available capital, which in turn forces them to further shrink their balance sheets, creating a vicious cycle. Tom Lee stated that the continued decline of the crypto market in recent weeks reflects the impaired function of these market makers.

The drop in trading volume further exacerbates liquidity issues. In this environment, even in the absence of new negative news, prices will continue to be pressured due to insufficient liquidity.

Historical Experience Provides a Time Frame: Two More Weeks Needed

Tom Lee compared the current situation to historical market crises. He mentioned the portfolio insurance that triggered the market crash in 1987 and the subprime mortgage collateral issues that led to the financial crisis in 2009, pointing out that the industry learns lessons and adjusts mechanisms after each crisis.

Regarding the recovery time for the cryptocurrency market, Tom Lee cited the experience from 2022, stating that the large-scale liquidation at that time took eight weeks to fully digest. Currently, it has only been six weeks since the October 10 incident, suggesting that the adjustment is nearing its end.

Tom Lee emphasized that the ADL mechanism and pricing methods "will not happen again" after this incident, and the industry will learn from it. He believes that compared to the excessive regulation following traditional financial crises, the advantage of the crypto market is that "there will not be excessive regulation," but it still needs to address the subsequent effects of liquidation.

Crypto Market Becomes a Barometer for the Stock Market

Tom Lee also pointed out that Bitcoin and Ethereum "have become leading indicators for the stock market to some extent." His team observed that in the market downturn on that day, Bitcoin turned downward ahead of U.S. stocks, confirming the leading nature of the crypto market.

This leading relationship stems from the process of liquidity release in the crypto market.

Tom Lee stated that the current performance of the stock market "resembles the echo of the event that occurred on October 10." Due to the higher degree of automation in the crypto market and the sensitivity of its liquidity mechanisms, its response to systemic risk is often quicker than that of traditional markets.