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Enormous volatility imminent for Bitcoin, derivatives data shows

Enormous volatility imminent for Bitcoin, derivatives data shows

Cryptocurrency traders frustrated with Bitcoin’s (BTC) recent price movement may soon witness some market volatility, as a large volume of open futures positions indicates that some price turmoil may be around the corner.

“Futures markets remain a powder keg for short-term volatility with Perpetual Futures Open Interest at ~250,000 BTC- a historically elevated level,” according to the most recent data from on-chain metrics platform Glassnode published on January 17.

An open interest above-250,000 BTC has coincided with volatility spikes in the past, Glassnode stated:

“Since April 2021, this has paired with large pivots in price action as the risk for a short or long squeeze increases, resolved in a market wide deleveraging events.”

Bitcoin: Futures Open Interest Perpetual. Source: glassnode

What is a futures contract?

A futures contract is an obligation to sell or buy a certain asset at a predetermined price on or before a given date. In contrast, perpetual are futures contracts that do not have an expiration date attached to them. The number of contracts that have been traded but have not been liquidated in the absence of an offsetting position is referred to as ‘open interest.’

Excess leverage or cash borrowed to increase the rewards on a transaction implies an abnormally high open interest and makes the market more sensitive to liquidations and the ensuing price instability that might occur. 

Due to a lack of margin, exchanges are compelled to close long or short contracts, which is known as liquidation. As a result, price movements become exaggerated, as has been witnessed multiple times during the last 12 months.

“In addition to large outstanding open interest, and negative funding rates, trading volume continues to drip lower, currently around $30B per day. This is coincident with levels in December 2020, and reflects a marked reduction from the 2021 bull market highs, hitting well above $70B/day. Should a deleveraging event occur, thinner trading volumes may accentuate the impact.”

Bitcoin: Futures volume Perpetual. Source: glassnode

Using open interest to gauge market bias

While not conclusive in terms of directional views on the market, open interest as a standalone indicator merely reveals the amount of money invested in derivatives. 

However, when combined with financing rates or the cost of maintaining long/short positions in perpetual futures, the market’s bias becomes clear. Having a positive funding rate indicates that long positions pay short for bullish exposure while having a negative funding rate means that short positions compensate for long positions for bearish exposure. 

Bitcoin’s financing rates recently fell into negative territory, according to Glassnode and this, coupled with the huge open interest, indicates that leverage is heavily skewed in a negative direction, which is why some investment management firms are projecting a Bitcoin bubble burst in 2022, citing reduced interest from investors. 

Therefore, if Bitcoin continues to trade sideways, the financing payment will become a hardship for shorts, and they will unwind their positions, resulting in further volatility. Similarly, a rise upward might result in forced liquidation of short positions, which can result in more turbulence.

Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

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