Why a 6-month-high Bitcoin open interest could spell trouble

Data from blockchain intelligence firm IntoTheBlock shows Bitcoin perpetual swap open interest (PSOI) hit close to $18 billion on Monday – a level not seen since mid-April, marking a 26 week high.

The firm suggests that a possible reason for this is due to traders overleveraging their positions. What’s more, further analysis reveals similarities with the most recent Bitcoin crash in early September.

“Overleveraged markets?

1/ #Bitcoin Perpetual Swaps Open Interest hits a 6-months high. The dollar amount of contracts outstanding is approaching $18b, a number not seen since April 14.”

What is a perpetual swap contract?

Crypto derivatives exchange BitMEX was the first to introduce perpetual swaps for crypto in May 2016. It refers to a type of derivative product that has become increasingly popular among crypto traders in recent years.

Per CoinGecko, the 24-hour trading volume of perpetual contracts was $178.1 billion. In comparison, trading volume for spot markets over the last 24-hours came in at $99.7 billion – almost half versus perpetual contracts.

Perpetual swaps enabled traders to take large positions relative to their account balance and speculate on the underlying asset’s value during the period the contract is held.

They are similar to futures in that both allow speculation on an asset’s future price through taking on the obligation to buy or sell on a set date at a predetermined price. But the main difference is that perpetual swap contracts do not have an expiry date, which means they must be pegged to the spot price of the underlying asset.

Derivatives exchanges use a funding rate mechanism to achieve this. It can be thought of as a fee or rebate for traders to hold positions.

When the price of a perpetual swap is above the spot price, this is known as a positive funding rate. In this case, long traders would pay a small fee to those who are short. Likewise, if perpetual swaps are trading below spot, shorters pay a fee to those holding long positions under a negative funding rate situation.

Why it matters

Into The Block raise concerns that the funding rate is spiking hard to levels last seen during the most recent crash, in early September. This resulted in the price of Bitcoin suffering a 20% swing to the downside bottoming at $42,800.

This event triggered a downtrend resulting in Bitcoin sinking below $40,000 (to $39,500) some two weeks after.

“As the Open Interest increases, the Funding Rate is quickly rising to similar levels as the ones seen during the September 5 crash. On exchanges like #Binance or #FTX, the funding is going as high as 0.03% and 0.11%.”

IntoTheBlock also states that “Bitcoin Basis,” which refers to the difference between spot and perpetual swap prices, shows significantly high levels with Binance varying by as much as +0.58%. As mentioned, the perpetual swap price should be pegged to spot.

This suggests perpetual swaps are potentially at overbought prices. Typically in situations like this, the market will correct itself by moving lower.

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