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This year has been difficult for crypto futures traders, but the present scenario appears to be considerably more favourable to Bitcoin bulls.
Bitcoin (BTC) has been unable to break above the $36,000 barrier for the previous three weeks, but bulls now have one less thing to worry about: cascading futures contract liquidations.
One could believe that a $1 billion liquidation is standard for Bitcoin. Traders, on the other hand, tend to recall the most recent dramatic price changes more than any other price shifts, especially when the price falls and individuals lose money.
This negative bias implies that, even when several price effects of similar strength occur, unpleasant feelings and occurrences have a greater impact on a trader’s psychological state.
For example, multiple studies show that winning $500 from playing the lottery is two to three times less ‘impactful’ than losing the same amount from the gambler’s personal wallet.
We are now six and a half months into 2021, and there have only been seven instances of a $1 billion or greater long contract liquidation. As a result, rather than being the norm, these are extremely rare scenarios that can only occur when traders use high leverage.
More notably, even after Bitcoin surged 19.4 percent on February 8, there was no $1 billion short-seller liquidation. These liquidations just demonstrate how leveraged longs are more irresponsible, leaving less margin on derivatives markets.
While regular traders employ heavy leverage and are eventually liquidated, more intelligent traders who bet on a price decline are typically fully hedged and making ‘cash and carry’ transactions.
This is one of the three reasons why $1 billion futures liquidation should not be a concern right now.
Cash and carry transactions have a minimal risk of liquidation.
Quarterly futures contracts are not often traded at par with normal spot exchange pricing. When the market is neutral or bullish, there is usually a premium that runs from 5% to 15% annually.
This rate (known as the basis) is frequently close to the stablecoin lending rate because the choice to postpone settlement implies that sellers want a higher price, resulting in the price differential.
This circumstance allows arbitrage desks and whales to buy Bitcoin on conventional spot exchanges while concurrently shorting futures contracts in order to receive the futures contract premium.
Although these traders will be displayed as ‘short interest’, they are effectively neutral. Thus, the result will be independent of the market moving up or down.
Longs are not now over-leveraged.
Traders were extremely positive on Bitcoin as it rose to a high of $65,800, but this mood shifted to pessimistic during the severe long contract liquidations between May 11 and May 23, when BTC fell 53 percent from $58,500 to $31,000.
The financing rate of perpetual contracts (inverse swaps) is a strong indicator of investor mood. When longs seek additional leverage, the signal will become positive.
There hasn’t been a single day since May 20 when the 8-hour funding rate was greater than 0.05 percent. This information suggests that purchasers are hesitant to utilise large leverage, and without it, creating $1 billion or greater liquidations is more difficult.
When the price of Bitcoin plummeted, so did open interest.
Every futures contract requires the same size buyer and seller, and open interest measures the aggregate notional in US dollars. This implies that when the price of Bitcoin falls, so does the indicator.
The figure above depicts how futures open interest topped $20 billion by mid-March. During that time, a $1 billion liquidation represented only 5% of the amount outstanding.
Given the current open interest of $11.8 billion, the same $1 billion amount would represent 8.5 percent of the total number of contracts.
In a nutshell, cascading liquidations are becoming considerably more difficult to execute since buyers are not employing excessive leverage and sellers look to be fully hedged. Bulls may rest easy as long as these indications do not change considerably.