Nearly $ 1 billion worth of Bitcoin (BTC) futures were liquidated on January 13, a day after the big shakeout. The continuous loop of liquidations leads to extreme volatility and sharp price swings in the cryptocurrency market.
What are forward liquidations and why are so many Bitcoin positions 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 tightens.
For example, if a trader borrows 10 times the original capital, a 10% movement of the price in the opposite direction would cause the position to liquidate. Once liquidated, the position becomes worthless and all initial capital is lost.
When Bitcoin saw the big 20% drop from $ 41,000 to $ 30,500 on January 12, nearly $ 2 billion in futures contracts were liquidated.
However, within 24 hours, an additional $ 1 billion in contracts were liquidated. Yet there have been no significant price fluctuations other than the range between $ 32,000 and $ 35,500.
The data shows that many traders over-leveraged their positions to sell BTC after recovering $ 30,500. Therefore, as Bitcoin hit $ 35,500, many short contracts were liquidated.
Cascading short-term contract sell-offs are probably the main reason for BTC’s rapid 20% recovery from $ 30,500 to $ 35,500.
The market is less indebted compared to the last two weeks. Futures funding rate hovers between 0.01% and 0.05%, meaning that buyers still represent the majority of the market but do not dominate the market.
For comparison, when Bitcoin was above $ 40,000, the funding rate for futures contracts was consistently around 0.1% to 0.15%. This meant that the market was overwhelmed with over-indebted buyers and traders.
Although the extreme volatility is not favorable, the upheaval of an over-indebted market is healthy and essential for the continuation of the rally.
If the Bitcoin market remains extremely over-leveraged while recovering above $ 40,000, it risks a correction much larger than 25%.
In previous bull markets, Bitcoin has frequently experienced declines of 30% to 40%, and as such the recent drop from $ 42,000 to almost $ 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 cooling of the Bitcoin futures market while consolidating $ 30,000 as a support area is very bullish for BTC’s medium-term outlook.
Whale clusters also identify the $ 30,000 level as a whale cluster support, which means that this psychological level will certainly be championed by the bulls if the price turns south.