An Overleveraged Crypto Market Leads to a 20% Drop: A Data Perspective by IntoTheBlock
Trading Analysis

An Overleveraged Crypto Market Leads to a 20% Drop: A Data Perspective by IntoTheBlock

1 year ago

This week, IntoTheBlock looks at what happened in the markets — is El Salvador the cause, or was the market overleveraged?

An Overleveraged Crypto Market Leads to a 20% Drop: A Data Perspective by IntoTheBlock

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Every other week, IntoTheBlock brings you on-chain analysis of top news stories in the crypto space. Leveraging blockchain’s public nature, IntoTheBlock’s machine learning algorithms extract key data that provide a deeper dive into the major developments in the industry. 

An Overleveraged Crypto Market Leads to a 20% Drop

In the morning of Sept. 7, crypto market sentiment was positive overall: El Salvador officially began to apply their Bitcoin law recognizing Bitcoin as a legal tender. The previous price action candles were bullish at a steady place in what seemed like the farewell to the $50K band price for Bitcoin, but in a matter of hours, all of the crypto market started to sell-off significantly. 
The crypto market capitalization dropped -20% from $2.37T to $1.97T in barely 12 hours. It quickly after recovered to around $2.0T, where it is at the time of writing, so the plunge accounts so far for a -15% over the last 24 hours. The price fall affected Bitcoin and Ethereum similarly. 
As of Sept. 8, based on IntoTheBlock’s capital markets insights.

While the price fall for Bitcoin was as much as -19% (from $53K to $43K), for Ethereum it accounted for -23% (from $3.9K to $3.0K). The bounce and quick price recovery was 11% for Bitcoin, while 18% for Ethereum. 

Taking into account these bounces and the last price action data, at the time of writing these price reductions are -14% for Bitcoin and -15% for Ethereum. Even after these drops, Ethereum’s 11.26% price increase in a month-over-month performance is outpacing Bitcoin, which sits around a 5.48% price increase.

This data shows that — besides Ethereum being a more volatile asset than Bitcoin — its recent price performance is still better than Bitcoin, even when the market drops considerably. As for market sell-offs, even though they come often in the crypto market, this one did not even turn the month-over-month return negative, and prices are lingering around last week’s levels.

Despite some news attributing the price crash to a “buy the rumor, sell the news” strategy due to El Salvador’s law, the data shows that the market was heavily leveraged and some market sell orders unleashed a liquidations cascade on long orders on futures derivatives markets, which exacerbated the price fall considerably. 
According to Bybit liquidation data, more than $3B has been liquidated in derivatives positions, more than 92% being long positions. Most of those $3B were in Bitcoin ($1.42B), while the other liquidations were notably in Ethereum ($949M) and Ripple ($225M). This is the biggest number of liquidations since the May 19 crash. 

Using IntoTheBlock data, it can be appreciated how the open interest in perpetual futures derivatives — which is the dollar amount of open positions —has decreased from $16.5B to $11.75B for Bitcoin. These positions usually involve high amounts of leverage.

As of Sept. 8, based on IntoTheBlock’s capital markets insights.

A reduction in open interest is partially due to liquidations forcing certain positions to close, but also due to traders who decide to close their positions without the need for them to have been liquidated — an action that is expected when the market starts to see high levels of volatility. 

Open interest data can be put into context by comparing it with the market capitalization of the coin. In this way, a ratio can be obtained that takes into account perpetual futures activity relative to the value of all the coins in circulation. This is the ratio of perpetual swaps open interest to Bitcoin’s market cap, which had been rising, as too many people had bullish leverage positions. 

In the next chart, it can be seen that when the open interest notional value has been greater than 1.55%, the market has reversed and rapid price action has followed.

As of Sept. 8, based on IntoTheBlock’s capital markets insights.

Did investors take advantage and buy the dip this time? The exchange flows indicator highlights trends of traders sending money in and out of exchanges. 

Net flows are positive when more funds are entering than leaving exchanges, and net flows are negative when a greater volume is being withdrawn from exchanges. As it can be seen on Sept. 6, the total balance of Bitcoin that left exchanges was more than the amount entering the exchanges by 8.3K BTC, which is around $428M. This means that many traders and investors took the advantage to buy Bitcoin and send it from centralized exchange to wallet addresses, which supposedly minimizes further selling pressure since the coins need to be located in exchange addresses for them to be able to be sold.
As of Sept. 8, based on IntoTheBlock’s capital markets insights.

Despite the quick bounce after the sell-off showing conviction by traders, the Sept. 7 price action is not overwhelmingly bullish so far and further price discounts would not be anything surprising. 

Historically, September has been the month with the worst returns on average for the crypto markets. Overall, this data analysis teaches the lesson that the derivatives market continues to rule the price action for the crypto markets. 

Furthermore, traders — especially those that use leverage — should consider proceeding with caution when open interest achieves higher and higher amounts and the price continues to grow for several days in a row without some meaningful correction. 

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