On Friday, August 19, the total capitalization of the cryptocurrency market decreased by 9.1%, but more importantly, the all-important psychological threshold of $1 trillion was reached. The market’s last venture below this threshold was just three weeks ago, meaning investors were fairly confident that the $780 billion low in total market capitalization on June 18 was just a distant memory.
Regulatory uncertainty increased on August 17 after the US House of Representatives Energy and Commerce Committee announced that it was “deeply concerned” that mining proof of work the demand for fossil fuels could increase. As a result, US lawmakers required cryptocurrency mining companies to provide information on energy consumption and average costs.
Typically, cryptocurrencies outside the top 5 assets by market cap are more affected by selling, but today’s correction showed total losses of 7% to 14%. Bitcoin (BTC) lost 9.7% testing $21,260 and Ether (ETH) fell 10.6% to an intraday low of $1,675.
Some analysts might suggest that daily corrections such as today are normal, rather than the exception, given the 67% annual volatility of this asset. In fact, today’s intraday drop in total market capitalization has exceeded 9% in 19 days of the past 365 days, but several aggravating factors make the current correction stand out.
BTC Futures Premium Expired
Fixed-month futures typically trade at a small premium to regular spot markets, as sellers demand more money to hold a settlement longer. Technically known as “contango,” this situation is not exclusive to cryptocurrency assets.
In successful markets, futures should trade at an annual premium of 4-8%, which is enough to offset risk plus the cost of capital.
According to OKX and Deribit Bitcoin futures premium, the negative swing of 9.7% on BTC caused investors to discard any hope by using derivatives. When the indicator moves into the negative zone, in a “look back”, it generally means that there is much stronger demand from leveraged shorts that are betting on a further decline.
Liquidations from leveraged buyers reached $470 million
Futures contracts are a relatively cheap and easy-to-use instrument that allows the use of leverage. The danger in their use is under liquidation, that is to say that the investor’s margin deposit is insufficient to cover his positions. In this case, the exchange’s automatic deleveraging mechanism kicks in and sells the cryptocurrency used as collateral to reduce exposure.
A trader can multiply his gains by 10 times using leverage, but if the asset falls 9% from its entry point, the position is closed. The derivatives market will then sell the collateral, creating a negative loop known as cascading liquidation. As shown above, the highest number of buyers were forced to sell from 12 June in the liquidation on 19 August.
Margin traders were too bullish and destroyed
Margin trading allows investors to borrow cryptocurrencies to leverage their trading position and potentially increase their returns. For example, a trader can buy bitcoin through Tether (borrowing USDT), which increases his exposure to cryptocurrencies. In contrast, borrowing bitcoin can only be used to sell it short.
Unlike futures, the balance between margin lending and short selling does not necessarily match. When the loan margin ratio is high, it shows that the market is bullish – on the contrary, a low ratio, a sign that the market is bearish.
Cryptocurrency traders are known to be bullish, which is understandable given the potential adoption of rapidly growing use cases such as decentralized finance (DeFi) and the perception that certain cryptocurrencies offer protection against dollar inflation. A 17x higher margin lending rate is not in favor of normal stablecoins and shows overconfidence from leveraged buyers.
These three derivative indicators definitely show that traders did not expect the entire cryptocurrency market to correct as strongly as it does today, nor for the total market capitalization to fall below the 1 trillion dollar threshold. This loss of confidence could cause bulls to further reduce their leveraged positions and possibly trigger new lows in the coming weeks.
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