What crypto can learn from traditional finance

ON BLACK MONDAY, 19 OCTOBER 1987, THE DOW JONES INDUSTRIAL AVERAGE PLUMMETED 22.6%, ITS LARGEST ONE-DAY DECLINE.

In October 2025, cryptocurrency markets had their 1987 moment, as roughly $19 billion in leveraged positions were liquidated in 24 hours.

GEORGE BRAMPTON AND WILL JUDGE

Research Analysts

THE TWO CRISES DISPLAY STARK SIMILARITIES: FUELLED BY LEVERAGE AND DERIVATIVES THAT MAGNIFIED RISK, ALGORITHMIC TRADING SYSTEMS TRIGGERED FORCED SELLING INTO MARKETS DRAINED OF LIQUIDITY.

Both episodes show how having poorly designed safeguards – or none at all – can turn financial innovation into systemic instability. These two crashes offer important lessons about market structure and risk that could strengthen systems in both crypto and traditional finance (TradFi).

BACK TO BLACK MONDAY

Between August 1985 and August 1987, US equities rose significantly, with the Dow Jones Industrial Average doubling (Figure 1). In the run-up to Black Monday, equity markets struggled, bond yields rose, and there were worries about currency wars. But the precise trigger of the crash is unknown. That Monday morning, the global sell-off in equities accelerated. Asian markets moved sharply lower, with Hong Kong’s Hang Seng down 11%.

When US equity futures opened after the weekend, the computerised order system already had $500 million of sell orders. This wave of selling pushed S&P 500 futures to nearly a 10% discount to the index and caused trading in over one third of Dow Jones stocks to open late.

Market makers on the New York Stock Exchange (NYSE), tasked with maintaining orderly trading, were quickly overwhelmed by the scale of orders and withdrew from the market once capital and risk limits were breached. This left few natural buyers, causing prices to gap lower (Figure 2).

The massive trading volumes overwhelmed the new computer trading systems. For example, the FedWire, the system for transferring funds from New York to Chicago, was shut down for extended periods due to a programming glitch. Some trades were reported with over an hour’s delay.

The extreme volatility also tested the newly formed derivatives market. Structural mismatches, such as different timelines for clearing and settling stocks and futures, resulted in significantly reduced liquidity during the crash. As prices tumbled, many traders faced intraday margin calls on futures positions. But they couldn’t raise cash by selling stocks, because proceeds from NYSE-listed trades would not settle for five days. Funding constraints worsened as margin calls tripled their previous record level, forcing participants to withdraw from the market and draining liquidity when it was needed most.

UNINTENDED CONSEQUENCES

The problem was exacerbated by portfolio insurance, a computerised strategy supposed to protect portfolios. This dynamic hedging strategy used index futures to replicate the payoff of a put option. So it mechanically sold futures as markets declined and bought back as they recovered. In theory, this would reduce downside risk; in practice, it embedded a feedback loop of selling into falling markets. By 1987, up to $100 billion was managed under portfolio insurance. So, when prices began to drop, vast automated sell orders hit a market already thin on liquidity.

What had been designed as a hedging mechanism became an accelerant: algorithms kept selling futures into a market with no bids, feeding a self-reinforcing cycle of decline.

In the aftermath, regulators concluded the crash had been less about market fundamentals than about market structure. The event spurred reforms such as circuit breakers – which force a pause in trading – and better coordination between futures and cash markets.

“The market, excluding Bitcoin and Ethereum, fell 33%.”

THE CRYPTO COLLAPSE

Nearly 40 years on, crypto investors suffered a similar crisis. The spark – a Trump tweet threatening new tariffs on China – prompted an initially orderly sell-off. As selling intensified, Binance, the world’s largest crypto exchange, representing around half of global spot trading volume, began to strain under the surge in activity, and market makers found it difficult to match buyers and sellers efficiently.

As Binance’s systems buckled, market makers initially widened their bid-ask spreads to manage the rising risk. But order book glitches worsened, and many market makers chose to retreat from the market, while others were effectively locked out by technical failures. With order books already thin, this created a liquidity vacuum that sent prices gapping lower and triggered a wave of margin calls and automated liquidations across leveraged positions (Figure 3).

SHUTTING THE STABLECOIN DOOR

At the centre of the turmoil was USDe, a stablecoin issued by Ethena that is designed to hold a $1 peg to facilitate blockchain-based payments. USDe briefly traded as low as $0.65 on Binance, even as it remained near $1 on other venues. Ethena confirmed its issuance and redemption mechanism was functioning normally, with $2 billion of withdrawals processed at par throughout the turmoil.1 So this was not a fundamental value problem, but a liquidity driven pricing problem.

As liquidity disappeared, extreme price dislocations emerged across Binance, with derivatives based on major tokens diverging violently from their underlying prices. One Ethereum-linked product traded at nearly a 90% discount, while prices for smaller tokens collapsed to near zero as order books emptied.2

The crisis was compounded by Binance’s internal collateral valuation system. Traditional clearing houses base valuations on volume weighted prices taken from multiple external venues. Binance, by contrast, priced margin and collateral primarily on its internal order book prices. As its prices diverged from other venues, Binance’s system treated its internal distressed collateral prices as accurate. Because Binance data feeds many derivative reference indices, its internal distortions soon spread across the broader crypto market.

This collateral markdown on Binance instantly pushed many leveraged positions below maintenance margin limits, triggering liquidations. This spread across other exchanges as each forced sale dumped more assets into an already illiquid market, turning a sell-off into a $19 billion liquidation cascade (Figure 4).

WHERE WERE THE CIRCUIT BREAKERS?

Most crypto trading occurs through futures, involving up to 100x leverage. Crypto has attempted to replicate and improve the safeguards of the TradFi system through code and smart contracts. For example, a trader can deposit $100 of margin to take a 5x long position on Bitcoin ($500). If Bitcoin’s price falls and the trader’s equity drops below the exchange’s required maintenance margin (typically a fraction of the initial margin), the exchange algorithm will liquidate the position following a set hierarchy.

Stage 1 The algorithm automatically liquidates the positions in the order book.

Stage 2 If there aren’t enough bids in the order book, the exchange’s insurance fund (built up in the good times) absorbs the losses and takes on the liquidated position.

Stage 3 Once the insurance fund is depleted, the exchange relies on a process known as auto-deleveraging (ADL). If a long position is liquidated due to insufficient margin but neither the order book nor the insurance fund can take on the position, the exchange ranks traders’ positions by factors such as profitability and leverage and then forcibly closes the most profitable positions to cover the losses on the liquidated positions. This safeguards the exchanges by socialising losses.

On 10 October, all three stages were activated on a number of exchanges. While ADL is designed to protect exchanges and the market by preventing uncontrolled liquidations, some exchanges were criticised for deploying it too aggressively. In this scenario, ADL amplified volatility partly because of the diversity of the trading strategies affected.

One group particularly hard hit were market-neutral traders. Market-neutral strategies hedge long positions with offsetting shorts to keep their overall market exposure near zero – or so they thought – while profiting from relative price moves. In a sell-off, their short positions offset losses on longs, insulating them from liquidation.

However, when exchanges activated ADL, many of these traders had their profitable shorts forcibly closed while their loss-making long positions remained open. To restore balance, they reopened shorts or closed longs, if not already liquidated, adding to selling pressure.

By the time the dust settled, Bitcoin had fallen more than 14% from its Friday high. Many tokens suffered even steeper losses. The market, excluding Bitcoin and Ethereum, fell 33% before bouncing back to a loss of 10.6%. Numerous tokens suffered more severe drawdowns but have not yet recovered.3

WHAT CAN CRYPTO LEARN FROM TRADFI?

This crisis may have been crypto’s 1987. Back then, traditional finance made sweeping changes, and crypto can learn from those lessons today.

At its core, the event exposed failures of both market structure and systems. In particular, reliance on internal pricing rather than cross-venue average prices allowed a dislocation to morph into a systemic collapse.

Market makers likely amplified the move, whether intentionally or not. With their visibility of the order flow, they were among the first to detect the exodus of liquidity and the growing instability of Binance’s systems. Many firms widened their spreads or withdrew altogether. In equity markets, designated market makers have obligations to provide quotes even at times of stress, in exchange for incentives and privileges.

In crypto, there are no such obligations. That asymmetry makes crypto liquidity abundant in rallies, but painfully absent in crises.

After Black Monday, equity markets introduced reforms. Crypto could benefit from similar guardrails

circuit breakers to stop feedback loops and allow liquidity to reset
market maker obligations or incentives to ensure market depth at times of stress
leverage limits – 100× exposure on unregulated offshore venues invites systemic instability
cross-venue price averaging to prevent a single exchange’s malfunction from cascading market-wide

Without such reforms, crypto’s incentives will remain skewed towards short-term profit rather than long-term stability. TradFi’s reforms after 1987 didn’t eliminate crashes, but they did make them survivable. Crypto could do the same now. But it faces a dilemma. While regulation might be beneficial, many see it as contrary to crypto’s principles of decentralisation, which gained support after the global financial crisis. Besides, implementing rules and regulations across many fragmented exchanges globally would be extremely difficult in practice.

Insurance funds and ADL are designed to maintain the stability of the system and are necessary when there are no central intermediaries. However, socialising losses incentivises ever greater leverage and risk taking. As perpetual futures expand into equity trading, the ever-increasing gamification of finance continues, highlighting moral hazard and perverse incentives.

WHAT CAN TRADFI LEARN FROM CRYPTO?

While crypto is the new kid on the blockchain and still has a lot to learn, it has already reshaped how TradFi thinks about efficiency, transparency and innovation. Crypto is unburdened by decades of legal and regulatory precedent which often creates friction and curbs innovation. Since Bitcoin’s launch in 2009, the industry has pioneered stablecoins, 24/7 trading, perpetual futures and programmable assets. These innovations are now being adopted by TradFi.

With the GENIUS Act, the US has formally brought stablecoins into the financial system. These blockchain-based instruments are convertible 1:1 into US dollars and are already widely used for trading and settlement in crypto markets. For TradFi, they offer something transformative: instant cross-border payments and real-time settlement at a fraction of today’s costs. By eliminating the lag between trade and settlement, they reduce counterparty and credit risk and improve capital efficiency.

Meanwhile, by representing real world assets such as real estate, bonds, money market funds and private assets on the blockchain, tokenisation can increase liquidity, accessibility and transparency. It improves price discovery of illiquid assets such as real estate, while enabling instant transferability and 24/7 settlement.

Around-the-clock trading and perpetual futures extend this innovation to market structure. Futures without expiry allow risk to be transferred continuously, narrowing market gaps and eliminating overnight pauses.

Programmable assets take this innovation further. Built on smart contracts, they can automate compliance processes (such as anti-money laundering and know your client) and payments of coupons and dividends, as well as the clearing and settlement of trades, all of which reduce operational time and cost. Meanwhile, blockchain’s transparency makes every transaction auditable, and its open source code base invites collaboration, accelerating technological progress.

TradFi is no longer ignoring these advances. Both Nasdaq and the NYSE are exploring extended trading hours, with plans to move towards 24-hour trading five days a week – a step that could pave the way for perpetual equity futures. Commodity trading firms, traditionally on the periphery of finance, are increasingly using stablecoins for cross-border settlement. With high transaction volumes in emerging markets, these firms stand to gain from lower capital lock-up and reduced counterparty exposure.

“The 1987 and 2025 crises both revealed how leverage, derivatives and algorithmic feedback loops can turn small shocks into systemic meltdowns.”

WIN-WIN

The 1987 and 2025 crises both revealed how leverage, derivatives and algorithmic feedback loops can turn small shocks into systemic meltdowns when liquidity evaporates and safeguards fail. While crypto survived its near-death experience, it can learn from the reforms that followed 1987: circuit breakers, cross-market coordination and liquidity obligations to prevent technology-driven spirals. In turn, TradFi can adopt crypto’s innovations: real-time settlement, transparency through open ledgers and continuous markets that reduce latency and friction. By learning from each other’s innovations, crypto and TradFi can build a more resilient financial system. ⬤

1 cryptodaily.co.uk

2 VanEck Crypto

3 Yahoo Finance