Bitcoin markets may be underestimating the risk of a large liquidation event, according to Tara McAulay, CEO of Pharos Fund and a former co-founder of Alameda Research.

She warns that traders are overly confident in Bitcoin’s recent low volatility, even though leverage in the market is quietly increasing.

"We've started to become increasingly concerned over the last couple of weeks that the market might be underweighting the risk of a large liquidation event occurring in the next three months, or certainly over the course of 2025,” McAulay said in an interview on Deribit’s Crypto Options Unplugged podcast with David Brickell, Head of International Distribution at FRNT.

She compared the current market setup to March 2020, when Bitcoin futures crashed 85% in a single day, triggering one of the largest liquidations in crypto history. Bitcoin’s market capitalization slid by nearly $40 billion to about $107 billion, according to CoinMarketCap.

Bitcoin’s hidden leverage problem

McAulay explained that many traders have built highly leveraged positions on the assumption that volatility will remain low. However, if Bitcoin experiences even a 20% price drop, it could set off a chain reaction of liquidations.

"We think that there's a lot of market participants now running Bitcoin positions with six or 7x leverage,” she said. “That maybe makes sense if you think volatility is likely to remain low, but would be quite dangerous and set off a very, very significant cascade of liquidations if there's a move of only 20% or greater."

She pointed out that the crypto lending market has changed significantly since 2022. Before, leverage was largely off-exchange, giving traders more time to meet margin calls. Now, more leverage is concentrated on exchange, which could lead to more violent unwinds.

Are we already in a bear market?

McAulay suggested that Bitcoin could already be in the early stages of a bear market — but investors don’t realize it yet.

"When we define the periods of a bear market, it's usually true that it takes about three months of being in one before everyone calls it as such," she said. "There's kind of this period of decline before you know you're already in a bear market, where prices have dropped off the high, and then they drop off a little bit more. And everyone keeps saying, 'Oh, it's coming back.'”

She noted that trading volumes have fallen 40% since December, with weak retail participation and fewer fresh capital inflows. While Bitcoin ETFs have continued to attract institutional money, she believes this is being offset by existing holders selling into strength.