Bitcoin derivatives deleveraging markets have undergone a sharp deleveraging over the past three months, a move analysts say has historically preceded market bottoms and healthier price recoveries. The aggregate open interest has decreased by about 31% since October, indicating a large liquidation of leveraged positions amid last year’s volatility. The market is beginning to transition away from the practice of using borrowed funds to purchase positions and is now more inclined to be structured in a more “clean” manner, posing fewer cascading risks.
Why open interest matters
The amount of open interest in a particular commodity, including futures and options contracts, serves as a barometer of activity in the derivatives market. The reduction in open interest often indicates that individuals are either liquidating their positions or forced to do so because they are over-leveraged and have suffered a loss due to the excessive speculative profit carried by the market. These reductions reduce volatility and the risk of an abrupt sell-off, as excessive leverage is removed or liquidated at the same time.
Deleveraging resets market structure
CryptoQuant analyst Darkfost called the drop in open interest a classic deleveraging signal. In past cycles, these periods often aligned with major turning points for Bitcoin. Removing excess leverage allows buyers and sellers to interact without pressure from forced liquidations, creating a stronger base for recovery.
Spot-driven gains ease downside pressure.
Bitcoin has experienced a significant price increase alongside a decline in open interest, which is indicative of shorts covering their positions rather than the creation of new leveraged positions. A reduction in sell-side pressure occurs when bearish traders are forced out of their position; therefore, these rallies usually have stronger sustainability. Since January of this year, Bitcoin has increased by approximately 10%, indicating that the current price rise is not sustained solely by borrowed capital.
Risks and cautious optimism
Even with deleveraging underway, derivatives markets have not yet fully transitioned to a bullish trend. As of this writing, Bitcoin’s open interest on exchanges totals approximately $65 billion, down from the $90 billion+ figure seen in early October 2022. According to Greek Live analysts, the recent trading action indicates that traders are reacting to events rather than establishing a clear upward trend. The removal of excess leverage lowers the likelihood of downside risk, but continued bearish market conditions may lead to further declines in open interest levels.
Conclusion
Bitcoin derivatives open interest has decreased by approximately 30%, helping eliminate most excessive leverage from the market. Whenever excessive leverage has been eliminated in the past, it has led to higher-quality and longer-lasting recoveries. Therefore, although there is still an element of caution, lower leverage and an increase in spot trader activity have improved the near-term market structure for Bitcoin and reduced the downside risk of price declines.
