Analyzing the true cause of Bitcoin's sharp decline from the perspective of options and hedging mechanisms

Author: Jeff Park (Bitwise Chief Information Officer)
Translation: Ding Dang, Odaily Planet Daily

Editor’s note: On February 5, the cryptocurrency market experienced another sharp decline, with 24-hour liquidation volumes exceeding $2.6 billion. Bitcoin briefly plummeted to $60,000, but the market does not seem to have a clear consensus on the causes of this drop. Jeff Park, Bitwise’s CIO, offers a new analytical framework from the perspective of options and hedging mechanisms.
As time passes and more data is disclosed, the situation is becoming increasingly clear: this intense sell-off is very likely related to Bitcoin ETFs, and Japan itself experienced one of the most volatile trading days in recent capital market history. Our conclusion is supported by the fact that IBIT’s trading volume on that day hit a record high—exceeding $10 billion, more than double the previous record (truly an astonishing figure)—and options trading volume also set a record (see the chart below, representing the highest number of contracts since the ETF launched).
Compared to past patterns, what is somewhat unusual is that, based on the volume structure, this time options trading was clearly dominated by put options rather than call options (further details will be elaborated below).


Meanwhile, over the past few weeks, we have observed that IBIT’s price movements are extremely closely correlated with software stocks and other risk assets. Goldman Sachs’ prime brokerage team also released a report indicating that February 4 was one of the worst single days for multi-strategy funds in history, with a Z-score as high as 3.5.
This implies an extremely rare event with only a 0.05% probability, a 3-sigma event (the classic “black swan” threshold, with about a 0.27% chance), which is ten times more rare. It can be described as a catastrophic impact. Usually, after such events, multi-strategy fund risk managers quickly intervene, demanding all trading teams to immediately and indiscriminately deleverage. This also explains why February 5 turned into a bloodbath.

In the context of multiple records being broken and prices trending sharply downward (a 13.2% decline in a single day), we initially expected ETF net redemptions to occur. Historical data supports this judgment: for example, on January 30, after IBIT fell 5.8% the previous trading day, it experienced a record redemption of $530 million; similarly, on February 4, IBIT saw about $370 million in redemptions amid continuous declines.
Therefore, in the market environment of February 5, a capital outflow of at least $500 million to $1 billion was entirely reasonable.
But the reality was quite the opposite—we saw widespread net subscriptions. On that day, IBIT added approximately 6 million shares, corresponding to an asset management growth of over $230 million. Meanwhile, other Bitcoin ETFs also experienced capital inflows, with the entire ETF system attracting a net inflow of over $300 million.
This result is somewhat perplexing. Theoretically, it can be loosely assumed that the strong rebound on February 6 somewhat alleviated redemption pressure, but turning from “possibly reducing outflows” to “net inflows” is a completely different matter. This suggests that multiple factors may have been at play simultaneously, but these factors do not form a single, linear narrative. Based on the current information, I can propose several reasonable hypotheses, and on these, I will offer my overall inference.
First, this round of Bitcoin sell-off likely touched some non-crypto-native multi-asset portfolios or strategies. These could be multi-strategy hedge funds mentioned earlier, or similar to BlackRock’s model portfolio business, which allocates between IBIT and IGV (software ETFs), and is forced to rebalance automatically during extreme volatility.
Second, the acceleration of Bitcoin selling is probably related to the options market, especially options structures associated with downside protection.
Third, this sell-off did not ultimately translate into capital outflows from Bitcoin assets, implying that the main driving force behind the market movement was “paper capital systems,” i.e., positions mainly managed by traders and market makers in a hedged state, adjusting their hedge positions.
Based on these facts, my current core hypotheses are as follows:

• The immediate catalyst for this sell-off was a broad deleveraging triggered when multi-asset funds and portfolios, after reaching a statistical anomaly in the correlation of risk assets, initiated widespread de-leveraging.
• This process then triggered an extremely fierce deleveraging wave, which included Bitcoin risk exposure, but a significant portion of that risk was actually in “Delta-neutral” hedge positions, such as basis trades, relative value trades (e.g., Bitcoin vs. crypto stocks), and other structures typically used by trading systems to “close out” residual Delta risk.
• This deleveraging then caused a negative Gamma effect, further amplifying downward pressure, forcing traders to sell IBIT. But because the sell-off was too intense, market makers had to sell Bitcoin net short without regard to their own inventories. This process inadvertently created new ETF holdings, reducing the market’s original expectation of large-scale capital outflows.

Subsequently, on February 6, we observed IBIT experiencing positive capital inflows, with some IBIT buyers (the question is, which type of buyers they are) choosing to buy on dips after the decline, further offsetting the potential for small net outflows.
Initially, I tend to believe that the initial trigger was a sell-off in software stocks, especially considering the high correlation between Bitcoin and software stocks—possibly even higher than its correlation with gold. Please see the two charts below.


This makes sense logically because gold is not typically a major holding for multi-strategy funds involved in financing trades, although it may appear in RIA model portfolios (pre-designed asset allocations). Therefore, I interpret this as further evidence that the epicenter of this turbulence is more likely within the multi-strategy fund ecosystem.
The second reasoning also becomes more plausible: this intense deleveraging process indeed involved Bitcoin risk in a hedged state. For example, CME Bitcoin basis trades have long been one of the preferred strategies for multi-strategy funds.

Looking at the full data from January 26 to yesterday (thanks to top industry researcher @dlawant for providing the data), the CME Bitcoin basis spread for 30, 60, 90, and 120 days clearly shows that the near-month basis jumped from 3.3% to as high as 9% on February 5.
This is one of the largest jumps we’ve observed since the ETF launched, almost certainly indicating that basis trades were massively forced to close out.
Imagine institutions like Millennium or Citadel being forced to liquidate basis trade positions (selling spot, buying futures). Given their size within the Bitcoin ETF ecosystem, it’s easy to see how this operation could cause significant shocks to the overall market structure. I have previously written my own analysis on this point.
Odaily Planet Daily supplement: Currently, a large portion of this indiscriminate US domestic selling likely comes from multi-strategy hedge funds. These funds often employ delta hedging strategies or run some form of relative value (RV) or factor-neutral trades, which are currently widening spreads and may also spill over into growth stock equities.
A rough estimate: about 1/3 of Bitcoin ETFs are held by institutional types, and roughly 50% (possibly more) of those are believed to be held by hedge funds. This is a substantial quick-money flow. When financing costs or margin requirements rise in the current high-volatility environment, risk managers intervene, leading to forced liquidations. When the basis yield no longer justifies the risk premium, these funds tend to capitulate. Notably, today MSTR’s dollar trading volume is among its highest ever.
This explains why the biggest risk of hedge fund failures is the notorious “common holder risk”: multiple seemingly independent funds hold highly similar exposures, and when the market declines, everyone rushes toward the same narrow exit, causing all downward correlations to approach 1. In such a low-liquidity environment, forced selling is a classic “liquidity risk” scenario, which we are witnessing today. Ultimately, this will be reflected in ETF capital flow data. If this hypothesis holds, after all these liquidations, I suspect prices will quickly reprice, but rebuilding confidence will still take some time.
This leads to the third clue. Since we understand why IBIT was sold off amid broad deleveraging, the question becomes: what is accelerating the downward move?
One possible “catalyst” is structured products. Although I do not believe the size of the structured product market alone could trigger this sell-off, when all factors align abnormally and beyond any VaR (Value at Risk) model expectations, they could become the acute trigger for chain liquidation events.
This immediately reminds me of my experience at Morgan Stanley. There, structured products with knock-in put barriers (where options only become effective if the underlying hits or crosses a certain barrier) often caused highly destructive consequences. In some cases, the change in option Delta even exceeded 1, a phenomenon not even considered in the Black-Scholes model—because under the standard Black-Scholes framework, vanilla options (the most basic European calls/puts) can never have a Delta exceeding 1.
For example, a note priced by JPM last November had a knock-in barrier exactly at 43.6. If these notes continued to be issued in December, and Bitcoin’s price fell by 10%, it’s easy to imagine a buildup of many knock-in barriers in the 38–39 range, creating what is called a “storm eye.”

In such cases where barriers are breached, if traders hedge knock-in risk by selling put options, then under negative Vanna dynamics, the speed of Gamma changes can be extremely rapid.
At this point, as traders, the only viable response is to aggressively sell the underlying when the market weakens. This is precisely what we observed: implied volatility (IV) collapsing to near 90%, approaching catastrophic levels of compression. Under such conditions, traders had to expand their short IBIT positions to the point of creating net new ETF shares.
This part requires some speculative reasoning, especially without more detailed spread data, but given the record trading volume that day and the deep participation of authorized participants (APs), such a scenario is entirely plausible.
Combining this negative Vanna dynamic with another fact makes the logic clearer:
Since overall volatility was relatively low earlier, crypto-native market clients have generally been inclined to buy puts over the past few weeks. This means that crypto traders are inherently in a short Gamma state and have underestimated the potential for extreme volatility. When a large move finally occurs, this structural imbalance further amplifies downward pressure.
The position distribution chart below also clearly shows this: in the $64,000 to $71,000 range, traders are mainly concentrated in short Gamma positions of put options.


This brings us back to February 6, when Bitcoin experienced a strong rebound of over 10%.
At this point, an interesting phenomenon is that CME open interest (OI) expanded much faster than Binance’s (thanks again to @dlawant for aligning hourly data to 4 PM Eastern).
From February 4 to 5, CME OI clearly collapsed, confirming the earlier judgment that basis trades were massively liquidated on February 5; on February 6, these positions may have been re-established to take advantage of higher basis levels, offsetting the outflow of funds.

Now, the entire logical chain closes again: IBIT’s subscription and redemption are roughly balanced because CME basis trading has recovered; but prices remain low because Binance’s OI experienced a significant collapse, indicating that a considerable part of the deleveraging pressure comes from short Gamma positions and forced liquidations in the crypto-native market.
This is my best explanation for the market behavior on February 5 and the subsequent February 6.
This analysis is based on several assumptions and is not entirely satisfactory, as it does not point to a clear “culprit” (like the FTX event). But the core conclusion is this: the trigger for this sell-off came from traditional financial risk-off behavior outside the crypto space, which just happened to push Bitcoin into a zone where short Gamma hedging accelerates the decline.
This decline was not driven by directional bearishness but by hedging needs, which ultimately reversed sharply on February 6 (unfortunately, this reversal mainly benefited market-neutral funds in traditional finance rather than directional crypto strategies).
While this conclusion may not be particularly exciting, at least it reassures that the previous day’s sell-off is likely unrelated to the 10/10 event.
Yes, I do not believe what happened last week is a continuation of the 10/10 deleveraging process. I read an article suggesting that this turmoil might have originated from a non-U.S., Hong Kong-based fund involved in yen carry trades that ultimately failed.
However, this theory has two obvious flaws. First, I do not believe any non-crypto prime broker would be willing to provide such complex multi-asset trading services with a 90-day margin buffer, especially when risk frameworks tighten and they haven’t already become insolvent.
Second, if the carry trade was unwound by buying IBIT options to “escape,” then Bitcoin’s price decline itself would not accelerate risk release—these options would just go out of the money, with Greeks rapidly approaching zero.
This means the trade must involve genuine downside risk. If someone is long USD/JPY carry and simultaneously selling IBIT puts, then frankly, such a prime broker would not deserve to continue existing.
The coming days will be critical, as we will get more data to judge whether investors are using this decline to establish new demand; if so, it would be a very bullish signal.
For now, I am quite encouraged by the potential capital inflows into ETFs. I still believe that genuine RIA-style ETF buyers (not relative value hedge funds) are insightful investors, and at the institutional level, we are seeing substantial real progress, both in the industry’s advancement and among my friends at Bitwise.
My focus is on those net capital inflows that did not accompany basis trading expansion.
Finally, all this again demonstrates that Bitcoin has integrated into the global financial capital markets in an extremely complex and mature manner.
This also means that when the market eventually moves in the opposite direction, the upward rally could be even steeper than ever before.
The fragility of traditional margin rules is precisely Bitcoin’s antifragility. Once prices rebound—something I see as inevitable, especially after Nasdaq raised the limit on open interest in options— it will be an extremely spectacular rally.