Nearly $1 billion worth of Bitcoin (BTC) futures contracts were liquidated on Jan. 13, a day after the big shakeout. The continuous loop of liquidations is causing extreme volatility and large price swings in the cryptocurrency market.
What are futures liquidations, and why are so many Bitcoin positions being liquidated?
In the Bitcoin futures market, traders borrow additional capital to bet against or for Bitcoin. The technical term for this is leverage, and when traders use high leverage, the liquidation threshold gets tighter.
For example, if a trader borrows 10 times the initial capital, a 10% price move to the opposite direction would cause the position to be liquidated. Once it is liquidated, the position becomes worthless and all of the initial capital is lost.
When Bitcoin saw the big 20% drop from $41,000 to $30,500 on Jan. 12, nearly $2 billion worth of futures contracts were liquidated.
However, within 24 hours, another $1 billion worth of contracts were liquidated. Yet, there were no large price swings other than the range between $32,000 and $35,500.
The data indicates that many traders have been overleveraging their positions to short BTC after it recovered from $30,500. Hence, as Bitcoin rallied to $35,500, many short contracts were liquidated.
The cascading liquidations of short contracts are most likely the main reason behind BTC’s swift 20% relief rally from $30,500 to $35,500.
The market is less leveraged compared with the past two weeks. The futures funding rate is moving in between 0.01% and 0.05%, which means buyers still represent the majority of the market but are not dominating the market.
By comparison, when Bitcoin was above $40,000, the futures funding rate consistently remained at around 0.1% to 0.15%. This meant that the market was overwhelmed by buyers and overleveraged traders.
Although extreme volatility is not favorable, the shakeout of an overleveraged market is healthy and essential for the continuation of the rally.
If the Bitcoin market remains extremely overleveraged while rallying above $40,000, it risks a much larger correction than 25%.
In previous bull markets, Bitcoin frequently saw 30% to 40% pullbacks, and as such, the recent drop from $42,000 to nearly $30,000 is nothing out of the ordinary for a BTC bull market.
Additionally, as the pseudonymous trader known as “Byzantine General” noted, the $30,000 area has become a major support level.
— Byzantine General (@ByzGeneral) January 13, 2021
The Bitcoin futures market cooling down while solidifying $30,000 as a support area is highly optimistic for the medium-term prospect of BTC.
Whale clusters also identify the $30,000 level as a whale cluster support, which means that this psychological level will certainly be defended by the bulls if the price turns south.