Bitcoin (BTC) might have struggled to break the $ 36,000 resistance in the past three weeks, but bulls now have one less thing to worry about: cascading liquidations of futures contracts.
One might get the impression that a $ 1 billion liquidation is common for Bitcoin. Still, more than any other price change, traders remember recent exaggerated moves, especially when the price crashes and people lose money.
This negativity bias means that even when different price effects occur with equal intensity, the unpleasant emotions and events have a more significant impact on a trader’s psychological state.
For example, several studies show that winning $ 500 from the lottery is two to three times less “effective” than losing the same amount from the player’s personal wallet.
Total liquidation of Bitcoin futures (red = longs). Source: Coinalyze
We currently have six and a half months in 2021 and there have only been seven times that there has been a liquidation of long contracts of $ 1 billion or more. So these are not the rule, but very unusual situations that can only occur when traders use excessive leverage.
More importantly, there wasn’t a $ 1 billion liquidation from short sellers, even when Bitcoin was up 19.4% on Feb.8. These liquidations only show how recklessly long leverages tend to leave fewer margins on the derivatives exchanges.
While retailers leverage high levels of leverage and eventually fall victim to liquidations, more intuitive traders who bet on price drops are likely to be fully hedged and engaged in cash and carry trades.
This is one of the three reasons why liquidating $ 1 billion futures shouldn’t be a problem right now.
Cash and carry trades have a low risk of liquidation
The quarterly futures contracts are usually not traded at the regular market prices. There is usually a premium when the market is neutral or bullish and is between 5% and 15% on an annual basis.
This rate (known as the base) is often similar to the stablecoin loan rate because the decision to postpone the settlement will result in sellers charging a higher price, and this is what causes the price difference.
This situation creates space for arbitrage desks and whales to buy bitcoin on regular spot exchanges while shorting out the futures to collect the futures contract premium.
Although these traders are shown as short interest, they are effectively neutral. Thus, the result is independent of whether the market is moving up or down.
Today, Longs are anything but fooled
Traders were extremely bullish on Bitcoin price as it rose to a high of $ 65,800, but that sentiment turned bearish after the brutal liquidations of long contracts between May 11th and 23rd, when BTC rose 53% from $ 58,500 $ 31,000 crashed.
Looking at the funding rate for perpetual contracts (inverse swaps) is a great way to gauge investor sentiment. Whenever long positions require more leverage, the indicator becomes positive.
Financing rate for perpetual Bitcoin futures. Source: Bybt
Since May 20, there hasn’t been a single day on which the 8-hour funding rate was higher than 0.05%. This evidence suggests that buyers are unwilling to use high leverage, and without it, it’s harder to get liquidations of $ 1 billion or more.
Open Interest also crashed when Bitcoin price imploded
Each futures contract requires a buyer and seller of exactly the same size, and open interest measures the total face value in US dollars. This means that as the Bitcoin price goes down, the indicator goes down.
Bitcoin futures (quarterly and perpetual) aggregate open interest. Source: Bybt
The graph above shows how futures open interest surpassed $ 20 billion by mid-March. During that period, a $ 1 billion liquidation was only 5% of the total outstanding.
Given the current open position of $ 11.8 billion, the same $ 1 billion amount would represent 8.5% of the total number of contracts.
In short, cascading liquidations are getting harder and harder as buyers do not use undue leverage and sellers appear to be fully hedged. If these indicators don’t change significantly, the cops can be left in peace.
The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph. Every investment and trading movement carries risks. You should do your own research when making a decision.