500,000 leveraged bitcoins

11 Oct 2022

500,000 leveraged bitcoins

The growing perps OI shows no signs of stopping. Now, notional open interest in BTC perps nears 500,000 BTC and seems to be in a parabolic growth trend amid BTC’s flattening volatility.

No signs of relief in BTC futures

In an idle futures market, CME has resumed trading at a discount to the spot market.Futures premiums stay suppressed this week as offshore exchanges see premiums flattening near 1%. Meanwhile, CME's 3mth basis falls to -1% as institutional traders remain reluctant to add long exposure in the current shaky environment.

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Source: Skew, Laevitas, Tradingview, CME *Closed Saturday - Sunday

A flat week of flows to ProShares long BTC ETF versus a noticeable growth of inflows into the short BTC ETF has likely contributed to pressuring CME’s basis into negative terrain. In sum, futures premiums still suggest that market participants remain cautious, with few notable changes from the last weeks.

Neutral to below neutral funding rates still

Funding rates have mostly trailed below neutral since our last report.

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Source: Skew, Bybit, Binance

Nevertheless, Binance perps have reached neutral terrain in the last 24 hours, accompanied by persistent growth in open interest. In the last week, notional open interest in BTC perps has surged from 428k to 498k. This is a concerning and unsustainable trend. The relatively orderly funding rate regime at near-neutral rates suggests that the growing leverage in the market is caused by a balanced demand for upside or downside exposure.In general, the market seems ripe for a squeeze, but assessing the direction based on funding rates provides little directional information. In this climate, it might be wise to avoid adding risk through leverage in the market. We elaborate on the high leverage below and later highlight the low IVs to shed light on a potential way to position for a possible normalization of the remarkably leveraged crypto derivatives market.

Perpetual open interest sees parabolic growth

The growing open interest (OI) shows no signs of stopping. Now, notional open interest in BTC perps nears 500,000 BTC and seems to be in a parabolic growth trend amid BTC’s flattening volatility. We’ve highlighted the growing open interest in the market since June, and the trend has only escalated since. The open interest has more than doubled in notional terms since mid-April.

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Source: Laevitas

This level of leverage is unprecedented in perpetual swaps history, and this OI surge has not happened in isolation in BTC. We witness similar extremes in ETH derivatives as well. Eventually, this trend is likely to be succeeded by a violent squeeze.

Open interest relative to market cap at ATH in ETH and BTC

ETH's and BTC's open interest relative to its market cap sits at all-time highs. A sign of instability to come?

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Source: Skew, Laevitas, Coinglass, Tradingview

The massive iceberg of leverage is not isolated to BTC. By comparing open interest relative to market cap, we see that leverage in both ETH and BTC derivatives sits at extremely high levels. Relative to its market cap ETH’s OI is more extreme than that of BTC, with ETHs OI to market cap ratio sitting at 4.24% versus BTC’s 3.21%. The gap between BTC’s and ETH’s OI to market cap ratio of 1.03% is far higher than the three-year average difference in relative OI. Since October 2019, the open interest to market cap ratio of ETH has averaged 0.46% above that of BTC. From September 2019 to August 2022, a larger relative leverage gap between BTC and ETH than today's level has only occurred on 36 occasions. 21 of these occasions originating in February 2021 during the start of the escalation phase of 2021’s altseason.

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Source: Skew, Laevitas, Coinglass, Tradingview

The elevated OI in ETH compared to BTC is related to hedged or directional positions ahead of the merge still being maintained, as the open interest has yet to see a substantial decline from the merge, where OI in ETH relative to market cap peaked at 4.5%. All traders should be aware of the potential short to medium-term implications of the extreme levels of leverage in the market. A winddown of this mountainous amount of leverage could be brutal, leading to enormous squeezes. This setup is potent for volatility and instability somewhere down the line. In order to offset directional risks, we view this time as a good time to explore option straddle strategies.

Timing right to bet on volatility?

The implied volatility in BTC options has declined towards April lows as BTC remains heavily rangebound. In light of the abnormally high leverage in futures and perps, the low IV may benefit traders seeking to bet on a structural shift in volatility. Straddle strategies might be a way to gain exposure for the more sophisticated investor.

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Source: Laevitas, Skew

Still, longer-dated options have yet to see a substantial fall in implied vols. Traders seeking to make bets on growing volatility should be aware that while the market structurally seems ripe for a burst in volatility, bear markets in crypto tend to be accompanied by prolonged flat markets. Nevertheless, compared to leveraged directional futures trades, we view option-based volatility plays as a more prudent way to gain exposure to a potential squeeze in the near to medium term in the market.