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The price of ADA plummeted the last time its futures open interest hit $1 billion, prompting traders to wonder if it is going to happen again.
Cardano’s ADA coin gained 816 percent in 2021, propelling the smart contract platform’s market capitalisation to $61 billion. To get a sense of how much this third-generation protocol has progressed, consider that the absolute king, Ether (ETH), had the same valuation just six months earlier.
If the price of AD changes, so do the options markets, and the approximately $1 billion in futures open interest represents both an advantage and a risk to the price. Cautious buyers will now wonder if the $200 billion in future liquidations are just around the corner, drawing parallels to the April 17 23 percent plunge.
DeFi is still looking for alternatives
There is no question that decentralised finance (DeFi) has fueled the rally in smart contract-focused cryptocurrencies, and the Ethereum network’s median fees above $35 prompted investors to look for alternatives.
Cardano employs a proof-of-stake process, but its “Goguen” upgrade, which will provide support for smart contracts and native token issuance, is still in the works. Though ADA is an inflationary currency, the production, which is currently 32 billion, will be limited to 45 billion.
On May 13, ADA hit an all-time high of $1.97, causing open interest in futures contracts to cross $940 billion. Given that ADA’s futures volumes seldom exceed $4 billion, this open interest statistic is very remarkable.
The liquidation of $195 million in long contracts on April 17 was partly liable for the 23 percent drop that happened over four hours. However, a large open interest cannot be identified as the main cause for cascading liquidations.
Leverage is the culprit when it comes to negative surprises
Open interest is an indicator of the number of open futures contracts, but it is often matched between buyers (longs) and sellers (shorts) (shorts). Thus, the most violent liquidations occur when longs use undue leverage, and the funding rate is the best way to quantify this.
Perpetual contracts, also known as inverse swaps, have a financing cost that is usually adjusted every eight hours. When (buyers) use more leverage, this premium rises, and their balances are gradually exhausted. When there is a supermarket shopping spree, the charge will hit 5.5 percent per week.
The map above depicts how exaggerated the buyers’ leverage was prior to the April 17 crash.
A support average of 0.30 percent per eight hours equals 6.5 percent monthly, which is a significant burden on those in long-term positions.
This high levels of support are rare, and it won’t take long to elicit stop orders. That’s just what happened on April 17, when Bitcoin’s (BTC) price plummeted to $52,000, dragging the whole cryptocurrency sector down with it.
However, the current financing cost on most markets is close to zero, showing a balanced use of leverage on the buy and sale sides. This suggests that, while rising open interest, there is no evidence that the derivatives market would trigger an ADA price collapse.