By 
The amount of leverage in the Bitcoin and Ethereum markets has reached record highs relative to their market caps, suggesting a high risk of volatility and a deleveraging event like the ones that have foreshadowed market bottoms in the past.
Leverage is an investment strategy of using borrowed capital to increase the potential return on an investment. As a trading mechanism, leverage allows investors to increase their exposure to the market by allowing them to pay less than the full purchase price of the investment.
The futures open interest leverage ratio, which indicates the amount of leverage that exists in a market relative to an asset’s market cap, reached its highest level ever recorded for Bitcoin at more than 3 percent of the BTC market cap after the Aug. 26 market-wide collapse, according to analytics firm Delphi Digital. Ethereum reached 2 percent.
Open interest is the total number of futures contracts held by market participants at the end of the trading day. It indicates market sentiment and the strength behind price trends.
Since Aug. 26, Bitcoin is down 7 percent and Ethereum is down 9 percent. The Bitcoin price has hovered around the $20,000 price mark ever since, leaving stakeholders and observers wondering if it has hit the bottom in this cycle. Ethereum was trading at $1,635.64 as of this writing.
“The rising ratio indicates open interest is outpacing market size and increases the risk of volatility due to future [long/short] squeezes,” said Lewis Harland, a researcher at Decentral Park Capital, according to Coindesk.
Andrew Krohn, an analyst at crypto research firm Delphi Digital, had a similar opinion, saying the ratio suggests that open interest is large relative to the market size and “implies a higher risk of market squeezes, liquidation cascades or deleveraging events.”
Leverage allows a trader to take a large long or short position by depositing a relatively small amount of money, called a margin, while the crypto exchange provides the rest of the trade value. That exposes futures traders to liquidations – forced closure of long or short positions due to margin shortages often caused by the market moving in the opposite direction of the trade.
These forced closures can pressure prices to move up or down, leading to increased volatility. The greater the degree of leverage relative to the market size, the bigger the risk of liquidations injecting volatility into the market.
Volatility describes how fast and how much the price of an asset changes. It is an important measure of risk in crypto markets.
For a company, the goal of deleveraging is to reduce liabilities. The most direct way to deleverage is to immediately pay off debts and obligations on its balance sheet. If unable to do this, the company or individual may be at risk of default. Too much systemic deleveraging can lead to financial recession and a credit crunch.
“Historically, such deleveraging events have foreshadowed market bottoms in BTC prices,” Krohn wrote. “However, this ratio has been on a strong upward trajectory since the market-wide plunge beginning in May-2022. Will we see a true deleveraging event before we can solidify a market bottom? Or is this just the outcome of higher appetite for leverage in a relatively new market?”
“Considering how crypto markets have performed since the Fed first began raising rates on July 26, 2022, and the fact that BTC and equities markets reflect a strong correlation, it wouldn’t be surprising to see a long drawn-out decline of the Bitcoin price over the coming months,” Ray Salmond wrote for CoinTelegraph.
“On the other hand, traders appear to still be bullish on the upcoming (Ether) merge.”
Comments