Decoding the Crypto Market Cycle: What Causes Markets to Go Up and Down?

Article author: Tulip King, Technical Director of MessariCrypto

Article translation: Block unicorn

Foreword:

• @BanklessVC's disgusting behavior clearly shows that we have entered a predatory, PvP (player vs. player) market. Protect yourself and your profits.

• I suspect that the cycle has peaked and this is a natural pullback as crypto markets try to release the pain — but that pain may last for a while.

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

What's driving the market higher?

It’s obvious that the reason the market is going up is because of new money flowing into the market. From now on, I will link the concept of new money flowing into the market 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 several ways:

1. Creating Wealth through Innovation (Airdrop)

Airdrops have become a powerful mechanism for redistributing value in crypto markets, creating significant wealth effects that benefit a wide range of participants. The Uniswap airdrop in September 2020 set the standard, distributing 400 UNI to over 250,000 addresses. Token(valued at approximately $1,400 at the time of issuance), with a final total value of over $900 million.

Jito airdrop is an important catalyst for the early bull run of Solana altcoins

The Jito airdrop in December 2023 distributed 90 million JTOs Token, with a total value of $165 million, and some users have reaped up to $10,000 in returns by transferring only $40 worth of JitoSOL. The Jito airdrop helped drive the growth of Solana’s total locked value (TVL) and promoted increased on-chain activity. This wealth effect spurred adoption and development 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 cover more than 2.3 million eligiblewallet, which will become one of the most widely distributed airdrops in crypto history. Jupiter's airdrop strategy is designed 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 effect is not limited to direct economic gains. These airdrops have transformed users into stakeholders, enabling them to participate in governance and protocol development. This mechanism creates a virtuous cycle: the benefited participants reinvest their wealth into the ecosystem, further driving market expansion and innovation.

These strategic distributions have proven to be powerful market catalysts, sparking broader bull cycles in their respective sectors. Uniswap’s airdrop ignited the DeFi summer of 2020, with its distribution sparking a wave of innovation in the decentralized finance space. Similarly, Jito’s December 2023 airdrop 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 effectively acted as economic stimulus for the entire ecosystem, creating self-reinforcing cycles of investment and innovation that defined their respective market eras.

2. Increase of wealth (marginal buyers)

When a market experiences a positive catalyst like a strategic airdrop, it attracts previously sidelined participants who bring in new capital and enthusiasm. The influx of these marginal buyers creates a virtuous cycle of market expansion and innovation.

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

Investors who were on the sidelines, after witnessing successful airdrops and subsequent market momentum, began to deploy capital, transforming from spectators to active market participants. This shift from cash to crypto assets represents real new money entering the ecosystem, not just a transfer between existing participants.

Large financial institutions are increasingly driving this shift, with firms such as BlackRock, Fidelity and Franklin Templeton creating products that connect traditional finance with digital assets. Their involvement helps legitimize the market and provides a more convenient entry point for sideline funds to enter the market. This expansion creates a positive-sum environment where new participants contribute to overall market growth.

Unlike a zero-sum trading environment, markets stimulated by new participants create a real wealth effect by expanding liquidity, increasing development activity, and expanding adoption. This positive feedback loop attracts more wait-and-see capital, further driving ecosystem growth.

3. Create wealth through leverage (multiplier expansion)

At the end of a bull market, leverage becomes the primary driver of price increases, marking the transition from value creation to value multiplication. As the market enters the price discovery phase, traders increasingly use leverage to amplify their positions, creating a self-reinforcing upward momentum cycle.

Interesting

When Bitcoin enters a price discovery phase above all-time highs, leverage ratios rise dramatically as traders seek to maximize their exposure. This has a knock-on effect where borrowed stablecoins fuel further buying, pushing up prices and encouraging more leveraged positions. This multiplier effect accelerates price volatility.

The continued increase in leverage also introduces systemic fragility into the market. As more traders take leveraged positions, the likelihood of cascading liquidations increases, especially as borrowing stablecoins becomes more expensive and difficult to access.

The rise in stablecoin borrowing costs is a key indicator that the market is entering its final phase. 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, leading to rapid price corrections. This fragility suggests that the bull market is coming to an end as the system becomes increasingly dependent on borrowed funds rather than underlying value creation.

What caused the market to fall?

It is also obvious that the market goes down because money is flowing out of the market. This is essentially the reverse wealth effect, where speculators take advantage of the animal spirits of the market, smart money takes chips off the table to lock in profits, and the foolish get liquidated.

1. Wealth is extracted from the market

The crypto ecosystem regularly undergoes cycles of value extraction, where savvy operators devise schemes to extract capital from enthusiastic market participants. Unlike 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 spent only 2 SOLs and drained thousands of SOLs from the ecosystem

Recent Aiccelerate DAO The launch showcased this evolution — despite the backing of high-profile advisors like the Bankless founder and industry veterans, the project was immediately criticized for selling tokens after insiders received them without a lock-up period. Even high-profile names can become a tool for rapid value extraction.

Celebrity tokens also embody this predatory behavior.contractand coordinated dumping, effectively transferring wealth from retail buyers to insiders, killing the altcoin cycle. These extraction events undermine market confidence and disincentivize legitimate participants. Rather than building a sustainable ecosystem, they create a cycle of distrust that harms the broadercryptocurrencyThe maturity of the ecosystem.

I've discussed this before in my Messari newsletter

Instead of reinvesting profits into ecosystem development, these schemes systematically extract liquidity from the market. The extracted funds often exit the crypto ecosystem entirely, reducing the total available capital for legitimate projects and innovation.

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 distinguish between legitimate projects and sophisticated frauds.

2. Sellers only

Were you surprised that BAYC topped the charts after only 3 months?

When the market starts to fall, a key asymmetry emerges - the gap between the sophisticated players who realize the market changes and the retail investors who still believe in the bull market thesis. At this stage, the market is not characterized by the entry of new capital, but by the systematic withdrawal of liquidity by experienced traders.

Professional traders and investment firms began to reduce their risk exposure while maintaining public optimism. Venture capital firms quietly liquidated positions through over-the-counter markets and strategic exits to protect capital while avoiding market impact.Xiaobai NavigationThis creates a false sense of stability, even though large amounts of capital have exited the system.

Smart investors began withdrawing liquidity from DeFi protocols and trading venues. This subtle but steady loss of liquidity created increasingly fragile market conditions, although its effects were not immediately visible to the average observer.

Looks like some smart investors are taking their chips off the table

Denial: While experienced players can reap profits, retail investors often still believe that declines are temporary buying opportunities. This cognitive dissonance is reinforced by the following factors:

• Social media’s information cocoon sustains bullish narrative

• Attachment to unrealized gains in the bull market

• Misinterpreting the mentality of "diamond hands"

Most retail investors missed the best exit point, held on during the initial decline, and tried to justify their decision. When the downtrend became apparent, a lot of value had been lost, panic intensified, and selling pressure intensified.

The steady withdrawal of professional capital creates deteriorating market conditions, with each subsequent sell order having an increasingly pronounced impact on price. The deterioration in market depth often goes unnoticed until large price swings 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 are forced to absorb increasing losses.

3. Leverage explosion (liquidation chain reaction)

The final stages of market capitulation reveal the devastating effects of excessive leverage, and as Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked.” The most dramatic crash in the crypto markets was a stark illustration of this principle.

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

The collapse of FTX further illustrates the dangers of hidden leverage. Alameda Research borrowed $10 billion of FTX customer funds, creating an unsustainable leverage structure that ultimately led to the collapse of both institutions. The disclosure that 40% of Alameda’s $14.6 billion in assets held illiquid FTT tokens exposed the fragility of their leveraged positions.

Old research by @Saypien_

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

The continuous liquidations revealed the true face of market depth. When leveraged positions were forcibly closed, asset prices plummeted, triggering further liquidations, forming a vicious cycle. This exposed how much of the market's apparent stability was supported by leverage rather than real liquidity.

The receding tide revealed that many of the supposedly sophisticated institutions were actually swimming naked, with inadequate risk management and excessive leverage. The interconnectedness of these positions meant that one failure could trigger a system-wide crisis, exposing the fragility of the entire crypto ecosystem.

Looking Ahead – Narrative Risk

The title of this post is a bit provocative. My gut tells me this is just a healthy, albeit painful, market clean-up. We will bounce back. Price targets for Bitcoin in particular are still pretty high — but I’ve taken my chips off the table and locked in Bitcoin gains that I’m willing to carry into the next cycle, if this is truly the end. Remember, no one ever went broke taking profits.

I have written many times about the importance of following the market narrative and not clinging to old coins. The longer this market is 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 takes longer to recover, then you should keep an eye on the newer coins to see if they can attract new inflows.

You should understand that I am telling you not to have a holding bias, and not to hold your coins into a downturn unless you really have a firm belief in them. Even if they create new all-time highs, I bet you will miss out on a lot of potential gains by not converting to new coins in time.

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

The article comes from the Internet:Decoding the Crypto Market Cycle: What Causes Markets to Go Up and Down?

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