Bitcoin Faces Low Risk of ‘Liquidations-Induced’ Price Volatility After 70% Surge
Liquidations refer to the forced closure of bullish long and bearish short positions in leveraged perpetual futures markets. They often exacerbate price moves.
Bitcoin (BTC) has surged 70% this year, hitting nine-month highs of over $29,000. While the sharp rally has brought the derivatives market back to life, the overall use of leverage remains muted, suggesting a low risk of “liquidations-induced” wild price swings.
Liquidations refer to the forced closure of bullish long and bearish short positions in leveraged perpetual futures markets, which allow traders to open positions worth much more than the money deposited as margin. The forced closure for cash or cash equivalent happens when the trading entity fails to meet the margin shortage stemming from the market moving against its bullish or bearish bet.
When the degree of leverage in the market – measured by the ratio between the dollar value locked in perpetual futures (open interest) and the cryptocurrency’s market capitalization – is high, short liquidations tend to exacerbate bullish moves. That, in turn, shakes out more shorts, leading to a short squeeze. Similarly, long liquidations exacerbate bearish moves, leading to a long squeeze.
The perpetual futures open interest to market ratio has been falling since FTX, which was once the third-largest cryptocurrency exchange in the world and one of the preferred avenues to trade perpetual futures, went bust in early November.
The ratio has stayed low despite the recent price consolidation, a sign of investors’ low appetite for risk, according to Blockware Solutions.
BY: Omkar Godbole
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