Regulatory uncertainty increased on August 17 after the United States House Committee on Energy and Commerce announced that they were “deeply concerned” that proof-of-work mining could increase demand for fossil fuels. As a result, US lawmakers requested crypto mining companies to provide information on energy consumption and average costs.
Typically, cryptocurrencies outside the top 5 assets by market capitalization have a greater sell-off effect, but today’s correction presented losses ranging from 7% to 14% across the board. Bitcoin (BTC) saw a loss of 9.7% as it tested $21,260 and Ether (ETH) declined 10.6% at its $1,675 intraday low.
Some analysts might suggest that a drastic daily correction like today is the norm rather than the exception, given the asset’s 67% annualized volatility. For example, today’s intraday drop in total market capitalization has increased by more than 9% in 365 days compared to the previous 19, but some aggressives are making this current correction stand out.
BTC Futures Premium Vanished
Fixed-month futures contracts typically trade at a slight premium to the regular spot markets because sellers demand more money to prevent settlement for a longer period of time. Technically known as “contango”, this situation is not exclusive to crypto assets.
In healthy markets, futures should trade at a 4% to 8% annual premium, which is enough to offset the risk and cost of capital.
According to OKEx and Deribit Bitcoin Futures Premium, a negative 9.7% swing on BTC has caused investors to eliminate any optimism using the derivatives instrument. When the indicator flips into negative territory, trading in “backwardation”, it usually means that there is a lot of demand for leveraged shorts that are betting on the downside.
Leveraged Buyers Liquidated Exceeds $470 Million
A futures contract is a relatively low-cost and easy-to-use instrument that allows the use of leverage. The danger of using them lies in liquidation, which means that the investor’s margin deposit becomes insufficient to cover their position. In these cases, the automatic deleveraging mechanism of the exchange buys and sells the crypto used as collateral to reduce exposure.
A trader can increase his profit by 10x using leverage, but if the asset falls 9% from its entry point, the position is liquidated. The derivatives exchange would proceed to sell off the collateral, creating a negative loop known as a cascading liquidation. As shown above, the August 19 selloff forced the largest number of buyers to sell since June 12.
Margin traders were overly bullish and were destroyed
Margin trading allows investors to borrow cryptocurrency to take advantage of their trading position and potentially increase their returns. As an example, a trader can buy bitcoin by borrowing Tether (USDT), increasing their crypto exposure. On the other hand, borrowed bitcoin can only be used to short it.
Unlike futures contracts, there is not necessarily a balance between margin long and short. When the margin-lending ratio is high, it indicates that the market is bullish – a low ratio, conversely, indicates that the market is bearish.
Crypto traders are known to be bullish, which is understandable given the adoption potential and rapidly growing use cases such as decentralized finance (DeFi) and the belief that some cryptocurrencies offer protection against USD inflation. Huh. Margin lending rates of 17x higher are not typical in favor of stablecoins and indicate excessive trust from leveraged buyers.
These three derivatives metrics show that traders were certainly not expecting the entire crypto market to correct as sharply as today, nor for the total market capitalization to recapture the $1 trillion support. This renewed loss of confidence could cause the bulls to further reduce their leverage and potentially trigger new lows in the coming weeks.
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