Partnered With:

Why is Bitcoin so volatile?

Read this article in 9 Minutes

If market leverage is too high, the risk of large liquidations in a short period of time is magnified.

Original title: "Why Bitcoin's Extreme Volatility?"

Source: LongHash

The price of Bitcoin has experienced extreme volatility in the past week, with repeated and fruitless tests of a resistance range between $24,200 and $24,300.

Behind these short-term price swings in the bitcoin market are a number of factors. These are: layers of clearing, high fees, a slowdown in greyscale inflows and a healthy market correction.

Layers of liquidations and high capital charges drove the market lower

On December 20, the currency was reinstated, with a sharp correction at $24,295. At that level, a pullback was expected as the exchange sought to show a mountain of sell orders above $24,000.

Over the next 17 hours, the price of bitcoin fell as low as $21,815. Behind the 10 percent plunge in prices was a series of liquidations on major futures exchanges, including Coinan, OKEx and Huobi.

In the futures market, buyers and sellers borrow more money to make big trades. The bitcoin futures market, for example, has a standard leverage ratio of 100. This means that a trader can build a $100,000 position for as little as $1,000.

If leverage is higher, the clearing price will be closer to the point at which traders buy or sell bitcoin. As a result, if market leverage is too high, the risk of large liquidations in a short period of time is magnified.

Hundreds of millions of dollars worth of long contracts were liquidated on December 21 as the price of Bitcoin fell below $22,000. At the time, $474 million worth of futures contracts were cleared within four hours, according to Bybt.com.

Massive layers of clearing can cause massive volatility, as they force traders to either buy at market prices or sell their positions at market prices over a limited period of time. In the Bitcoin market on December 21, many holders and buyers of long contracts suffered massive liquidation, causing the price of bitcoin to fall.

The most direct indicator of whether the futures market is biased towards buyers or sellers is the capital rate. The futures exchange uses a system called Funding to keep the market balanced.

The system requires buyers to compensate short-sellers if there are more buyers in the market, and vice versa. Therefore, if the fees are high, it means there are too many buyers in the futures market, so going long bitcoin becomes a crowded trade.

On December 20, solstice 21, bitcoin's funding rate was particularly high, at one point reaching 0.1%. Since the transaction compensation fee is the capital fee multiplied by the size of the entire position, it can bring high fees to the trader.

For example, let's say a trader has a $100,000 position and is long bitcoin. With a 0.1 per cent fund rate and allocation every eight hours, the trader had to pay $300 a day for compensation alone.

How might a slowdown in greyscale inflows lead to a healthy correction

Analysts at jpmorgan noted in a note that a slowdown in grayscale inflows would increase the risk of a bitcoin pullback.

The analysts all said that institutions were behind the continued rise of Bitcoin through 2020. As LongHash previously reported, the CME and grayscale data clearly show a surge in institutional interest in Bitcoin in 2020.

When demand from bitcoin's biggest buyers begins to wane, the chances of a deep correction increase. If such a trend occurs, the bitcoin market is likely to see layers of liquidation and a downward trend in prices, which could exacerbate the bitcoin decline.

However, the chain analyst said that even if bitcoin corrected as institutional demand slowed, it was likely to be for a short period.

Ki Young Ju, CryptoQuant's CHIEF executive, noted that the risk of a correction as a result of whales selling bitcoin on exchanges had become higher. However, he said the currency would recover quickly after the pullback, possibly because buyer demand would offset the pullback. He explained:

"I am aware of the risk of selling as Top100 is active on the exchange, but I do not short BTC because there is so much buying power. I'm going long with low leverage. When the 'whale inflow' indicator reaches 2 BTC, it is likely to point to a sideways or bearish trend. BTC has been sideways since November... Even if we see some correction, it will be sharp and it will come back very quickly."

A positive macro trend is that exchange outflows are decreasing while exchange reserves of stabilisation currency are increasing. This suggests two things: that the number of giant whales actively sold on exchanges may be declining; Capital that chose to stay on the sidelines is starting to re-enter the cryptocurrency market.

Investors tend to store the money they get from selling bitcoin or other cryptocurrencies in stable coins, such as Tether. They did this because it was easier to use Tether to buy other cryptocurrencies like BTC, ETH, etc.

So if stability reserves on major exchanges start to increase, investors are using stability to repatriate dollar deposits into Bitcoin and other major cryptographic assets.

In the short term, the wild card in the bitcoin price cycle is gray. According to the Skew, the grayscale Bitcoin trust has reached a premium of 41%, meaning that investors have bought bitcoin via the consistency Skew 41% higher than the spot price.

The grayscale premium rises because there are no exchange traded funds (etfs) in the US, so grayscale bitcoin trusts are the preferred investment vehicle for many institutional and accredited investors.

As long as the grayscale bitcoin trust premium remains near record highs, the risk of a sudden decline in institutional demand for Bitcoin in the near term remains low. Given that the premium shows no sign of falling any time soon, the probability of a bitcoin pullback due to reduced grayscale inflows remains low.