Bitcoin, Ethereum derivatives are unwinding

Hull Invest

A look at Bitcoin and Ethereum derivatives shows that they have been hit by the FTX fallout, with data analyzed by CryptoSlate showing that over 160,000 BTC have been unwound since the beginning of October.

The data shows that about $3 billion worth of futures contracts were settled in two months.

Cryptocurrency derivatives are an important indicator of overall market health. It also serves as a guide as to where the price will go next as it shows how leveraged the market is.

Bitcoin futures open interest shows a sharp decline in the amount of funds allocated to open futures contracts, now back to levels recorded in July 2022.

Bitcoin Futures Open Interest
Graph showing open interest in bitcoin futures (source: glass node)

A similar trend can be seen in Ethereum derivatives. Nearly 2 million ETH have been unwound since October, bringing Ethereum futures open interest back to his early 2022 levels.

Ether Futures Open Interest
Chart showing open interest in Ethereum futures (Source: Glassnode)

Another way to estimate the amount of leverage in the market, apart from open interest in futures contracts, is to look at the Estimated Leverage Ratio (ELR). The estimated leverage ratio is the ratio of the futures contract’s open interest divided by the corresponding exchange’s reserves. It shows how much leverage an exchange has and can be used to gauge trader sentiment. A high ELR indicates an over-leveraged market and volatility. On the other hand, a low ELR indicates a deleveraged market and indicates stability.

When the ELR starts to decrease, it indicates that more investors are starting to take leveraged risks and close positions. An increase in ELR can also indicate confidence in a leveraged position, but usually indicates that the market is ripe for high leverage risk.

The ELR peaked at 0.41 in October 2022 when the price of Bitcoin hovered around $19,000. Since then, this ratio has decreased significantly and is now at 0.32. This decline indicates that a significant number of derivative positions have been closed in just two months, providing some stability to the market.

elbitcoin derivatives
Chart showing the estimated leverage ratio (ELR) for Bitcoin futures from July 2020 to December 2022 (Source: Glassnode)

However, compared to last year, the ELR remains high. If the ratio starts to increase or stays in a sideways trajectory, it will continue to deleverage more.

While this could threaten Bitcoin’s price, a deep dive into its derivatives shows hope for stability.

The percentage of open interest margined in Bitcoin is much smaller than open interest margined in USD and USD-pegged stablecoins. Decreasing.

btc futures open interest derivatives
Chart showing percentage of crypto margined Bitcoin futures open interest from June 2021 to December 2022 (Source: Glassnode)

Declining percentage of crypto margin open interest shows that investors are taking less risk in Bitcoin. The ongoing unwinding will ultimately have a positive effect on the market. Washing out leveraged positions creates short-term volatility, but leads to healthier markets in the long run, creating a solid foundation for future accumulation.

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