Bitcoin

Bitcoin futures

Futures Markets See New Highs in Open Interest
While on-chain has stayed quiet, the leverage in Bitcoin derivatives market has been growing at an aggressive pace This speaks to an outsized interest in Bitcoin price action as a speculative bet, rather than the relatively tepid demand for Bitcoin in spot markets.
Leading our assessment of derivatives is the growth of Futures Perpetual Open Interest, which is the sum value of all open contracts in the continuous contracts market. Shown here in BTC terms, Perpetual Open Interest has reached new all-time highs of 264k BTC in the face of recent price declines, rising +42% since December 4 and surpassing the previous high of 258k BTC set on November 26.
With the first principles understanding that price declines will inherently close out long traders, a growth in Open Interest in recent days hints at short traders layering on bets into market weakness.
Live Chart
Leading the rapid growth of futures speculation are users on Binance, far and away the largest Bitcoin futures exchange by volume and size. Since May 2021, Binance has enjoyed the lion's share of Futures Open Interest among all exchanges, with a notable increase in market share during recent weeks. Since the dramatic purge on December 4th, Binance has absorbed 9.4% of Bitcoin's Futures Open Interest, and now dominates with a 30% market share.
The second largest exchange by Open Interest market share is FTX with 19%, surpassing the Chicago Mercantile Exchange (CME). CME had seen a jump in market dominance in October at the launch of the $BITO ETF, but is now the third largest at 15% of Futures Open Interest.
The dramatic leap in Futures Open Interest can be viewed in another way: representing itself as a leverage ratio against the Market Cap. Typically, periods where Futures Open Interest exceeds >= 2% of Market Cap are short-lived, and tend to end with a dramatic flush of margin.
De-leveraging events can occur in either direction, and at times have triggered despite an Open Interest leverage ratio below 2%, like on September 7 when El Salvador made Bitcoin legal tender. The combination of elevated Open Interest plus a big news event catalyzed a volatile move down.
However, each instance where leverage exceeded 2% in the past year ended with a swift liquidation of contracts. At time of writing, Futures Open Interest Leverage Ratio is at 1.98% so there exists a non-trivial risk of high volatility in the short term.
Live Workbench Chart
Short-Term Squeeze of Shorts?
A byproduct of consistent downtrends in price are the liquidation of confident long traders trying to catch a falling knife. A great way to view the trend of liquidations is via the dominance oscillator between long and short liquidations.
Since November, Bitcoin futures has been in a regime of long liquidation dominance, where traders betting on "Number Go Up" are consistently on the losing side. This value recently spiked to a local high of 69%, its highest value since the May 2021 crash.
Factoring in this observation with the aforementioned rise of Open Interest into declining price, and the probability of a local reversal is increasing. Short traders, who have not been punished for taking on increasing risk, may find themselves candidates for a near-term squeeze.
Live Chart
As the volume of open contracts in futures rise to new highs, the daily sum of traded volume in futures has been trending in the opposite direction. Large price movements result in contracts changing hands and stop losses being triggered. In sideways price action, traders get away with not having to close their positions, allowing volumes to decline in periods of consolidation while Open Interest can remain high.
Futures Volume saw its zenith in the first half of 2021, where daily trading exceeded $75 billion/day for weeks at a time. Following the market decline of 50% into July, the October rally to all-time highs was supported by volume back up around $65 billion/day.
In the current environment however, the 14-day average of daily Futures Volume is around $38 billion/day, the same level it was in the depths of the July lows. Low trading volumes can however create environments of reduced market depth, and limited resistance against rapid price moves. Should a deleveraging event follow, in a low liquidity environment, the magnitude of the price move may well be greatly amplified.
Live Chart
Rounding out our look at derivatives is Options Open Interest. Coming into December, all eyes were on the end-of-year strike on December 31, following months of buildup to the tune of more than $11 billion in contracts. Many of these contracts were dominated by bulls, with a particular emphasis on Bitcoin prices exceeding $100k.
By January 1, Options Open Interest was down to $6.2 billion from a December 31 value of $11.2 billion, a haircut of -45% ($5B). The end-of-year strike was the largest of 2021 in percentage closures, but only the second in total dollars. The March 26 strike saw a record $5.3 billion closed at expiration, a reduction of -36%.
Live Chart
In summary, the current Bitcoin market structure can be best described as having:
Tepid demand for spot, with the majority of onchain metrics describing a dominance of HODLers in accumulation, typical of bearish markets with low retail/tourist interest.
Derivatives market leverage is at high risk levels around 2% of the market cap. This is strongly lead by Binance markets, and open interest has increased as prices decline.
An elevated risk of a deleveraging exists, coupled with low trading volumes, and an elevated probability of short-dominance in futures markets.
Alongside very oversold indicators in onchain spending activity, this suggests a short squeeze is actually a reasonably likely near-term resolution for the market. Whether it can overcome macro headwinds, and reestablish a convincing uptrend will be a focus for upcoming newsletters.