Liquidations Expected as Bitcoin Open Interest and Leverage Ratio Rise
Over the past month, Bitcoin has been trading relatively flat, ranging between $18,400 and $22,800.
Amid a deteriorating macroeconomic backdrop and escalating events in Eastern Europe, some analysts see this as the start of BTC’s decoupling from traditional markets.
Estimated Bitcoin Futures Leverage Ratio
The Bitcoin Futures Estimated Leverage Ratio (ELR) metric refers to the proportion of open interest divided by an exchange’s reserves. Open interest refers to the number of derivative contracts outstanding (unsettled) at a given time.
This metric expresses the average leverage currently used by derivatives traders in the market. A a high ELR often coincides with BTC spot volatility. In this scenario, derivatives traders are at risk of liquidation.
The chart below shows ELR at an all-time high of 0.34, suggesting high liquidation risk. Although direction calls cannot be made with certainty, the likelihood of a downward move is higher, given that BTC is trading on higher macro time frames.
Open Interest on Futures Contracts
As mentioned earlier, open interest is a measure of outstanding futures contracts at a given time period. High open interest means that new traders are opening positions giving a net increase.
The chart below shows the build of open interest from a yearly low in March, gradually climbing sharply in the present. With a current reading of around 600,000 contracts, it is clear that derivatives traders continue to pile in, despite the deteriorating macro environment.
Similarly, Open Interest Cash-Margined (OICM) also represents interest, but from a cash flow perspective. As expected, with open interest rising since the March lull, the money flowing into Bitcoin Futures has also trended higher.
Except for a dip in mid-September, the OICM resumed its uptrend to peak at around 360,000.
During the 2021 bull run, traders overwhelmingly used Bitcoin to open futures, presenting significant but acceptable risk during euphoric times.
Now, in the bear market, traders have shifted to cash, which has caused the Open Interest Crypto-Margined metric to drop from a peak of 70% in April 2021 to 38% currently.
Futures Perpetual Funding Rate
The perpetual funding rate of futures contracts (FPFR) refers to periodic payments made to or by derivatives traders, both long and short, based on the difference between the perpetual contract markets and the spot price.
During periods when the funding rate is positive, the price of the perpetual contract is higher than the marked price. Therefore, long traders pay for short positions. In contrast, a negative funding rate shows that perpetual contracts are priced below the marked price and short traders are paying for longs.
The mechanism was designed to keep futures prices aligned with the spot price. FPFR can be used to gauge traders’ sentiment as a willingness to pay a positive rate suggests bullish conviction and vice versa.
Since May, the funding rate has been broadly neutral. But starting in late September, the chart below shows that the funding rate has been mostly positive, with the past few days seeing a swing between negative and positive funding.
Over the weekend ending October 9, a sharp drop in the discovery rate to -0.005% was followed by a strong move in the opposite direction, reaching +0.0058%.
The estimated leverage ratio and open interest are at all-time highs, and with positive funding rates in effect, the crypto market is significantly hot and over-leveraged to the upside.
Widespread selloffs could occur in the near term, triggering a Bitcoin-led asset price decline.