Bitcoin (BTC) price rose 22.5% in March, but as the price rose some buyers began to take advantage of excessive leverage, according to derivatives data. Meanwhile, open interest in futures hit a record high of $ 22.5 billion, which made investors question how sustainable the current rally is.
Being optimistic, especially in a bullish market, cannot be viewed as worrying. Still, a yellow flag is hoisted when buyers use excessive leverage as it can lead to large liquidations during a sell-off.
BTC / USD 6-hour chart. Source: TradingView
After peaking at $ 58,300 on February 21, Bitcoin saw a 26% correction the following week. This move wiped out over $ 4.5 billion in futures contracts, virtually eliminating any excessive leverage from buyers. This was confirmed by the annualized premium for the 1 month futures contract, which fell to 17%.
BTC futures aggregate open interest in USD. Source: Bybt.com
On March 13, open interest for BTC futures hit a record $ 22.5 billion, a monthly increase of 39%.
There are some derivative metrics that need to be checked to see if the market is overly optimistic. One of them is the futures premium (also known as the base), which measures the price gap between the futures contract prices and the regular spot market.
The 1-month futures should normally trade at an annualized premium of 12% to 24%, which should be interpreted as a borrowing rate. By postponing billing, sellers are asking for a higher price, resulting in a price difference.
OKEx BTC 1-month futures premium. Source: Skew
The graph above shows the Bitcoin futures base with a high of 60% which is usually unsustainable. A base rate of over 35% signals excessive leverage on the part of buyers and creates the potential for massive liquidations and subsequent market crashes.
Notice how this indicator was corrected after the BTC price fell from the high of $ 60,000 on March 13th. A similar move took place on February 21, when BTC hit an all-time high of $ 58,300 and crashed 22% in less than 48 hours. The futures base rate was adjusted to a neutral level of 16%.
A base level above 24% is not necessarily a warning of a crash, but it does reflect the high leverage of the use of futures buyers. This overconsciousness usually carries greater risk when the market deviates 10% or more from its high.
It’s also worth noting that traders sometimes increase their leverage during a rally, especially on weekends, but later buy the underlying asset (spot bitcoin) to adjust risk.
The move to $ 61,750 did not liquidate the sellers
Those betting that Bitcoin price will hit $ 65,000 and above will be pleased to know that open interest has increased during the 71% rally since February. This situation suggests that short sellers are likely to be fully hedged and taking advantage of the futures premium rather than effectively anticipating a downward trend.
With the strategy outlined above, professional investors are essentially doing cash and carry deals, which consist of buying the underlying asset and selling futures contracts at the same time.
These arbitrage positions usually do not involve any liquidation risk. Hence, the current rise in open interest during a strong rally is a positive indicator.
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