On Friday, August 19, the total cryptocurrency market capitalization fell by 9.1%, but more importantly, the all-important $1 trillion psychological support was touched. The market’s last foray below this figure came just three weeks ago, meaning investors were pretty sure the $780 billion total market capitalization low on June 18 was merely a distant memory.
Regulatory uncertainty increased on August 17 following the Committee on Energy and Commerce of the US House of Representatives announced that it was “deeply concerned” that trial-of-work mining might increase demand for fossil fuels. As a result, US lawmakers asked cryptocurrency mining companies to provide information on power consumption and average costs.
Typically, selling has a bigger impact on cryptocurrencies outside of the top 5 assets by market cap, but today’s correction saw losses ranging between 7% and 14% across the board. Bitcoin (BTC) suffered a 9.7% loss as it hit $21,260 and Ether (ETH) dropped 10.6% to its intraday low of $1,675.
Some analysts might suggest that violent daily corrections like today’s are the norm rather than the exception, considering the asset’s 67% annualized volatility. The point is that today’s drop in total market capitalization exceeded 9% in 19 days out of the last 365, but a few aggravations make this current correction stand out.
BTC futures premium faded
Fixed-month futures contracts typically trade at a slight premium to regular spot markets because sellers demand more money to hold the settlement longer. Technically known as “contango”, this situation is not exclusive to crypto assets.
In healthy markets, futures should trade at an annualized premium of between 4% and 8%, which is enough to offset the risks plus the cost of capital.
According to the Bitcoin futures premium on OKX and Deribit, the negative 9.7% swing in BTC caused investors to brush off any optimism using derivative instruments. When the indicator goes into the negative zone, trading in backwardation, it usually means that there is a much higher demand for leveraged shorts betting on further downside.
Liquidations of leveraged buyers exceeded USD 470 million
Futures contracts are a relatively cheap and easy instrument that allows you to use leverage. The danger of using them lies in liquidation, that is, the investor’s margin deposit being insufficient to cover their positions. In these cases, the exchange’s automatic deleveraging mechanism kicks in and sells the crypto used as collateral to reduce exposure.
A trader can increase their profits up to 10x using leverage, but if the asset drops 9% from its entry point, the position is closed. The derivatives exchange will proceed to sell the collateral, creating a negative loop known as a waterfall liquidation. As shown above, the August 19 selloff featured the largest number of buyers forced to sell since June 12.
Margin Traders Were Overly Bullish and Destroyed
Margin trading allows investors to borrow cryptocurrencies to leverage their trading position and potentially increase their profits. For example, a user might buy Bitcoin by borrowing Tether (USDT), thus increasing their exposure to cryptocurrency. On the other hand, Bitcoin lending can only be used for shorting.
Unlike futures contracts, the balance between long and short margin positions is not necessarily even. When the ratio of margin loans is high, it indicates that the market is bullish; the opposite, a low ratio, signals that the market is bearish.
Cryptocurrency traders are known to be bullish, which is understandable considering the potential for adoption and fast-growing use cases like decentralized finance (DeFi) and the perception that certain cryptocurrencies provide protection once morest dollar inflation. American. A loan rate The 17x margin spread favors stablecoins is not normal and indicates overconfidence from leveraged buyers.
These three derivatives metrics show that traders did not expect the entire cryptocurrency market to correct as sharply as it did today, nor for the total market capitalization to touch the trillion dollar support once more. This renewed loss of confidence might cause the bulls to further reduce their leveraged positions and possibly trigger new lows in the coming weeks.
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