In a recent turn of events, the cryptocurrency market has witnessed a significant correction, primarily driven by a surge in spot market activity and the resulting overleveraging of traders. This price adjustment has also coincided with a return to normalcy in funding rates for crypto futures contracts, following a period of unusually high fees paid by traders to maintain their long positions.
large movements in the spot markets propelled the open interest in crypto futures contracts to over $35 billion. This surge indicated that many traders had adopted highly leveraged positions, hoping for further price increases. This figure represented a substantial increase of nearly 40% compared to the open interest of around $24 billion at the end of October, according to available data.
Bitcoin’s impact on turbulence, liquidations, and recovery
As traders piled into leveraged positions, funding rates for futures contracts reached some of their highest levels in recent months. Funding rates are periodic payments made by traders based on the price difference between futures and spot markets. During this period, traders were paying fees ranging from 0.2% to 0.5% every eight hours on their borrowed funds to sustain their long positions. In practical terms, speculators were shelling out as much as 50 cents in exchange for every $100 position they held.
However, this elevated funding environment also had an unintended consequence. Some market observers began to caution against a potential market downturn, as traders were increasingly incentivized to go short or bet against a price rise. Short positions earned fees from those who were going long, creating a situation where longs paid short when funding was positive, and vice versa when funding turned negative.
This culmination of factors seemingly played a role in the market correction that unfolded on Tuesday. As traders sought to lock in profits following a week-long price increase, nearly 90% of bullish bets were liquidated, amounting to over $300 million in total. Bitcoin traders incurred losses of $120 million as prices dropped by 4%, while Ether traders lost $63 million. Additionally, futures tied to XRP and Solana’s SOL saw over $30 million in cumulative liquidations.
Liquidation occurs when an exchange forcibly closes a trader’s leveraged position due to a partial or total loss of the trader’s initial margin. It happens when a trader fails to meet the margin requirements to keep a leveraged trade open.
Return to normal funding rates
The occurrence of large liquidations can often signal the local top or bottom of a steep price move. Consequently, funding rates have now reverted to more normal levels, averaging around 0.01% on most exchanges as of Wednesday morning.
Despite the recent correction, the cryptocurrency market has shown resilience, with gains of over 6% in the past week. These gains have been driven by heightened expectations of a potential approval for a spot Bitcoin exchange-traded fund (ETF) in the United States. Some analysts have reiterated a 90% likelihood of such approval taking place in January.
In a related development within the traditional finance sector, industry giant BlackRock has filed for an Ethereum (ETH) ETF. This move has contributed to boosting the value of Ethereum, along with other alternative cryptocurrencies like Avalanche, Solana, and Polygon.