So far in the month of March, Bitcoin’s price has rallied by 22.5%, but as the price has gone up, some of the buyers have started using excessive leverage, as per the derivatives data. Meanwhile, a record high of $22.5 billion was hit by futures open interest, which prompted investors to question whether the current rally is sustainable or not. It should be worrisome to be optimistic, particularly when the market is bullish. Nevertheless, the use of excessive leverage by buyers tends to raise a yellow flag because a sell-off would result in large liquidations. On February 21st, Bitcoin peaked at $58,300 and then the following week saw the cryptocurrency face a correction of 26%.
Futures contracts worth $4.5 billion were wiped out as a result, which effectively eliminated any excessive leverage by buyers. This was confirmed when there was a decline in the annualized premium of one-month futures to 17%. The open interest on BTC futures on March 13th hit a record $22.5 billion, which is a monthly increase of 39%. There are a few derivative metrics that can be reviewed to see if the market is overly optimistic. Futures premium, which is also known as basis, is one of these metrics.
It measures the price gap that exists between the regular spot market and futures contract prices. The annualized premium of one-month futures should be between 12% and 24% and should be considered a lending rate. When sellers postpone settlement, they ask for a higher price and this can result in a price difference. The Bitcoin futures basis had peaked at 60%, which makes it unsustainable. If the basis rate is above 35%, it highlights excessive leverage from the buyers and can create the potential for huge liquidations, thereby resulting in market crashes. This indicator was corrected when Bitcoin’s price dropped from the $60,000 mark it reached on March 13th.
Something similar had happened on February 21st when Bitcoin had reached its all-time high of $58,300 and then fell by 22% in less than 48 hours. Meanwhile, a neutral level of 16% was seen in the futures basis rate. It is not necessary that a basis level of more than 24% is an indicator of a crash, but it is a reflection of high leverage use by futures contract buyers. There is a greater risk associated with this over confidence if the market falls by 10% or more from its peak. It should also be noted that sometimes traders tend to increase their leverage during a rally, particularly on weekends.
However, they later buy the underlying asset, Bitcoin in this case, for adjusting the risk. There are people who are betting that Bitcoin will move past the $65,000 mark and the good news is that there has been an increase in open interest since February during the 71% rally. This could indicate that all short-sellers are fully hedged, which means that they can take advantage of the futures premium rather than effectively expecting a fall. This means that cash and carry trades are being made by professional investors.
