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3 reasons for the fall of Bitcoin yesterday; Will the market situation worsen?

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The total value of the digital currency market on Friday, August 19 (August 28), decreased by 9.1%; But more importantly, the market capitalization reached the psychological support of $1 trillion. Investors had forgotten that the last decline in market value occurred less than 3 weeks ago, when on June 18 (June 28) this index reached about 780 billion dollars; But has the upward trend of recent weeks stopped and the market situation can still get worse?

To Report After the US House Energy and Commerce Committee announced on August 17 that it is deeply concerned about the increased demand for fossil fuels to power the mining of proof-of-work digital currencies, Cointelegraph reported. It also increased compared to the upcoming legislations. As a result of these concerns, US lawmakers have asked cryptocurrency mining companies to provide information on their energy consumption and average costs.

Typically, overall price declines (caused by increased selling pressure) have less impact on the price of Bitcoin and the top 4 cryptocurrencies than other market assets. However, this market correction resulted in a 7-14% drop in the price of the top cryptocurrencies. Bitcoin fell 9.7% after reaching $21,260, and Ethereum fell 10.6% to its daily low of $1,675.

Some analysts believe that considering Bitcoin’s annual volatility of around 67%, the formation of such drastic corrections on a daily time frame is normal. For example, during the past 365 days, the daily decline rate of the total market value has exceeded 9% in 19 days (such as August 28), but the existence of some factors have made the recent fall seem more prominent than the previous falls.

Bitcoin futures trading premium reaching zero

Typically, monthly Bitcoin futures trade at a small spread or premium to the spot market, as sellers demand more money to push back the settlement date of the trades over the long term. This situation is not unique to the digital currency market and is known as Contango in the financial markets.

In this situation, the futures price of a commodity is higher than its spot price and usually occurs when traders expect the price of the asset to increase over time. In healthy markets, futures contracts are traded at an annual premium of 4-8%, which is enough to compensate for risks and capital costs.

Annual premium for trading 3 months of Bitcoin futures
3-month Bitcoin futures annual premium chart.

The zeroing of bitcoin futures trading premiums in the OKX and Deribit exchange, along with the 9.7% drop in the price of this digital currency, has caused the optimism of investors to use derivative markets to disappear. When the index in the chart above enters the negative area, the inversion stage (Backwardation) occurs. This means that the price of futures contracts is lower than that of spot contracts and there is more demand for opening leveraged short trading positions that count on further price reductions in the future.

Liquidation of 470 million dollars of traders

Futures contracts are a relatively low-cost and easy-to-use leveraged tool for traders. However, there is a risk of “liquidation” in their use, which means that the investors’ margin deposit or the money they have in their account is not enough to cover the loss of their trading positions. In such a situation, the deleveraging mechanism of the exchange starts working automatically and sells the digital currency used as collateral, with the aim of reducing the loss.

The total liquidation value of bitcoin to dollar transactions on a daily basis
Chart of the total value of liquidated trading positions in the Bitcoin market over a one-day period.

A trader may increase his profit by 10x using leverage, but if the asset price drops by 9% from his entry point, his position will be closed. In this situation, the exchange will sell his collateral and his trading position will be liquidated. The chart above shows that the number of liquidated long positions on August 19 was the highest since June 12.

Excessive optimism of margin traders

Margin trading allows investors to open a larger trading position and increase their potential profit by borrowing digital currency. For example, a trader can borrow Tether from an exchange to buy Bitcoin, increasing the risk and potential profit of his trade. Also, he can use the borrowed Bitcoin to open a short trading position.

Unlike futures contracts, there is not necessarily an equilibrium between long and short margin trading volume. However, a high margin lending ratio is a sign of a bullish market trend. On the other hand, the lowness of this coefficient can be a sign of the downward trend of the market.

BTC/USDT Margin Lending Ratio on OKX Exchange
BTC/USDT margin lending ratio on OKX exchange.

Cryptocurrency traders are known for their perpetually bullish outlook. This view is due to the adoption potential, the rapid growth of the use cases of digital currencies such as the DeFi industry and the perception that some of these assets are immune to the growth of dollar inflation. However, a 17x margin lending ratio in favor of stablecoins is not normal and could be a sign of overconfidence by traders in long leveraged positions.

Examining these three benchmarks in the derivatives markets shows that traders definitely did not expect the entire cryptocurrency market to correct sharply yesterday. Nor did they expect the market cap to test the $1 trillion support again. This renewed decline in market confidence may reduce the volume of buyers’ leveraged positions, possibly triggering further price declines in the coming weeks.

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