Bitcoin’s Leverage Ratio Plummets To Historic Lows
- Bitcoin’s estimated leverage ratio hits lowest since Dec. 20, 2021, signaling low price volatility in the future.
- A dwindling ratio also means less sensitivity of the spot market to the derivatives market activity.
- A reduced bitcoin price volatility may bring more mainstream participation in the crypto market.
A key metric that is used to gauge the use of leverage in the bitcoin (BTC) market continues to slide, signaling low price volatility in the future.
This is particularly noteworthy since the use of leverage to magnify returns in the market has been on a steady decline since October. The estimated leverage ratio, which is calculated by dividing the dollar value locked in the active open perpetual futures contracts by the total number of coins held by derivatives exchanges, fell to 0.195 on Wednesday, marking the lowest it has been since Dec. 20, 2021, according to data tracked by analytics firm CryptoQuant.
The dwindling ratio also means that the spot market is becoming less sensitive to the derivatives market activity. This means that wild price swings, such as the ones we saw on Wednesday, may become increasingly rare going forward. This is because the use of leverage exposes traders to liquidations, which can lead to forced unwinding of bullish long or bearish short positions due to margin shortage. Mass liquidations can thus end up injecting volatility into the market.
Perpetuals are futures contracts with no expiry that use the funding rate mechanism to keep prices tethered to the spot market price. Leverage allows users to open positions worth more than the money or coins deposited at the exchange. A reduced bitcoin price volatility may bring more mainstream participation in the crypto market, which could be a positive sign for the future of the industry.
Interestingly, the estimated leverage ratio has been in free fall since Sam Bankman Fried’s FTX went bust in early November. The exchange was known for its perpetual futures product, offering leverage up to 20 times the collateral traders posted. The continued decline in the leverage ratio suggests that bitcoin’s year-to-date rally of 75% has been spot market driven. The popular assumption is that the spot market is a proxy for long-term investors, while derivatives represent institutions and sophisticated traders/speculators. All in all, the decreasing leverage ratio points to a more stable and sustainable market for bitcoin and other cryptocurrencies.
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