Cryptocurrency Market Trends: Navigating Leverages, Premiums, and Potential Risks
Summary:
Over the past 10 weeks, the cryptocurrency market showcases a bullish trend with high capitalization metrics. While Bitcoin (BTC) saw a substantial growth, analysts fear a potential correction due to the excessive demand for leverage long positions. Regardless of the current optimism, market dependency on futures presents a risk. The monthly contracts are preferred by pro traders due to the absence of a funding rate. While the 15% premium on Bitcoin is somewhat expected, the future premiums tend to zero out upon contract expiry, prompting market makers to short. Leveraged retail traders prefer perpetual contracts; these indicate an increased demand for long positions as the funding rate is positive. Currently, the average weekly funding rate is 1.2%, which may lead to exorbitant prices during bull runs, but there is no immediate risk of broad liquidations.
For the past 10 weeks, the metrics for the capitalization of the cryptocurrency market have consistently been drawing an ascending pattern, marking a bullish trend. Despite facing resistance at the $1.7 trillion market cap and not breaking through it recently, the momentum is not deterred. In December, Bitcoin (BTC) reached unprecedented highs in 20 months, crossing the $44,000 mark. Meanwhile, Ether (ETH) saw its rise stagnate at $2,400. Some observers suggest that too much demand for leverage long positions may provoke a market adjustment; but is that a valid claim?
The total capitalization of the cryptocurrency market, USD billion (one day), Source: TradingView
Future market dependencies could result in a slew of liquidations, irrespective of current bullish trends, possibly driven by the anticipation of a Bitcoin spot exchange-traded fund (ETF) getting approved in March. Hence the demand for leverage is closely watched by market analysts as it provides insights into potential derivatives-driven sell-offs. Let's delve into the specifics of how this works.
Bitcoin is seeing a (mildly) optimistic outlook among professional traders
To figure out the market direction taken by whales and market makers, the premium on Bitcoin futures, also known as the basis rate, is scrutinized. Monthly contracts are the preferred choice among professionals as they don't have a funding rate, allowing these contracts to trend 5%-10% above regular spot markets, this covers longer settlement periods.
Three-month Bitcoin futures premium VS spot price, Source: Laevitas
The three-month Bitcoin futures premium has maintained above the neutral marker of 10% since 1st December, suggesting strong demand for long positions. However, the ongoing 15% premium is expected considering the BTC price appreciated by 11.5% alone in December. On the flip side, those looking to wager on a price drop currently have a comfortable buffer, with the futures contract sitting $1,800 above the spot price.
The futures premium goes to zero on the expiry date (30th March) for the mentioned three-month contract, which prompts arbitrage desks and market makers to short (sell) the futures and hedge by buying spot Bitcoin, a strategy known as "cash and carry", creating an environment akin to the fixed-income market.
BTC, ETH, SOL, XRP see yearly record funding rates
When it comes to leverage, retail investors generally opt for the perpetual contract, also called an inverse swap. Built into these contracts is an adjustable rate charged typically every eight hours, causing their price to mirror the spot markets, foregoing the traditional premium seen in monthly contracts. Hence, these contracts are comparatively straightforward, but they come with the unpredictability of varying funding expenses.
When the funding rate is positive, it signifies an greater demand from long holders (buyers) for leverage. Conversely, a heavier demand for leverage from short holders (sellers) can turn the funding rate negative.
Cryptocurrencies' weekly funding rate, Source: Coinglass
Note the weekly funding rate peaked at a one-year high, between 1% and 1.2% for the top five cryptos, including XRP (XRP) and Solana (SOL), ranked in terms of futures' open interest.
Is the crypto market overheated?
Under normal circumstances, steadfast optimism could keep such indicators above 2% for several weeks or longer, unless confronted with a sudden price correction or price stabilizing phase. On the other hand, the funding rate could stay negative during bear markets as long as short position demand surmounts leverage use for long positions.
Related: India advances to block Binance, Huobi, and other international crypto exchange URLs
The present average weekly funding rate of 1.2% may appear a bit too high. Still, the majority of retail traders are after brief profits, possibly for a few weeks until the Bitcoin spot ETF verdict. Thus, they are in a better position to handle the costs, if they have even realized their existence. When investors are overly driven by profit and lack understanding of funding rate charges, it paves the way for exorbitant prices during bullish markets. Therefore, in the short term, there's no set boundary on what is deemed excessive concerning the funding rate.
Analysis of the three-month futures premium reveals the cryptocurrency futures are running business as usual. In other words, there's no imminent danger of widespread liquidations owing to excessive leverage utilized by retail traders through perpetual contracts.
Please note the information provided here is purely for informational purposes and shouldn’t be taken as investment or legal advice. The views, thoughts, and opinions expressed in this article are solely those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Published At
12/29/2023 5:41:28 PM
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