Bitcoin, Ethereum derivatives unfold

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Examination of Bitcoin and Ethereum derivatives shows that they have been affected by the FTX fallout, with data analyzed by CryptoSlate showing that over 160,000 BTC have been unwound since early October.

This data indicates that approximately $3 billion in futures contracts closed in two months.

Cryptocurrency derivatives are an important indicator of overall market health. They also serve as an indicator as to the next direction that prices might take, as they show the amount of leverage the market is sitting on.

Open interest on Bitcoin futures shows a sharp decline in the amount of funds allocated to open futures, which has now returned to the levels seen in July 2022.

Chart showing Bitcoin futures open interest (Source: Glassnode)

A similar trend is also present in Ethereum derivatives. About 2 million ETH has been unwound since October, with open interest on Ethereum futures now back to early 2022 levels.

Chart showing Ethereum futures open interest (Source: Glassnode)

Besides open interest on futures contracts, another way to estimate the amount of leverage in the market is to look at the estimated leverage ratio (ELR). The estimated leverage ratio is the ratio of the open interest on the futures contracts divided by the reserves of the corresponding exchanges. It shows the extent of leverage on exchanges and can be used to gauge traders’ sentiment. A high ELR indicates an overleveraged market and incoming volatility. A low ELR, on the other hand, indicates an unleveraged market and indicates stability.

When the ELR starts to drop, it shows that more and more investors are starting to eliminate leverage risk and close their positions. And while an increasing ELR can show confidence in leveraged positions, it usually indicates that the market is ripe with high leverage risk.

In October 2022, the ELR peaked at 0.41 when the Bitcoin price hovered around $19,000. Since then, the ratio has decreased significantly and currently stands at 0.32. This decrease shows that a significant number of derivatives positions have been unwound in just two months, bringing some stability to the market.

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

But, ELR still remains high compared to last year. If the ratio starts to rise or remains on a sideways trajectory, more leverage will continue to loosen.

And while this may threaten Bitcoin’s price, diving deeper into its derivatives shows some hope for stability.

The margined open interest percentage in Bitcoin is much smaller than the margined open interest in USD and USD-pegged stablecoins. Around 35% of open interest is crypto margined, up from around 41% at the start of the year.

Graph showing the percentage of open interest on crypto-margined Bitcoin futures from June 2021 to December 2022 (Source: Glassnode)

A decreasing percentage of crypto margin open interest shows that investors are taking less risk with their Bitcoin. The current outcome will ultimately have a positive effect on the market. Eliminating leveraged positions will cause short-term volatility but lead to a healthier long-term market, creating a solid foundation for future accumulation.

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