The number of open positions in bitcoin futures traded on major exchanges, including Binance and the Chicago Mercantile Exchange, continues to rise, and what appears to be a proliferation of short sellers indicates a dour market mood. That may bring volatility on the higher side.
Open interest, or the number of futures contracts traded but not squared off with an offsetting position, rose to 397,873.36 BTC on Tuesday, reaching the highest tally since May 18, according to data from the blockchain analytics firm Glassnode. The dollar value of the number of contracts open remained flat at around $12 billion.
When measured in kind, the metric has risen by more than 100,000 BTC since late May. According to experts, the uptick in open interest indicates traders have been opening short or sell positions amid flat-to-negative price action in the cryptocurrency. Bitcoin has mainly traded in the $30,000 to $40,000 range in the past two months, barring a couple of short-lived dips to $29,000.
"In my opinion, it's mostly short futures, given the persistent negative funding rates in perpetual markets over past few weeks as well as futures markets trading in backwardation," Shiliang Tang, chief investment officer of LedgerPrime, a $130 million crypto hedge fund, told CoinDesk.
The perpetual market has consistently seen negative rates since mid-May.
Calculated every eight hours, the funding rate refers to the cost of holding long/short positions in the bitcoin perpetuals (futures with no expiry) market. The metric is used by exchanges offering perpetuals to balance the market and guide perpetual prices toward the spot price.
A positive funding rate means longs are paying shorts to keep the position open, and the market is skewed bullish. Meanwhile, a negative funding rate implies a bearish market positioning.
The three-month basis, or the difference between the price of the three-month futures and the spot price, recently turned negative, flipping into the so-called backwardation, a sign of bearish sentiment among futures traders.
"Institutional investors seem very cautious at the moment and in general seem to be in the process of de-risking," Arcane Research said in a weekly research note published Tuesday. "The futures premiums on the unregulated offshore derivatives market is also trending towards zero, with FTX still trading at a slight premium."
One question is whether the uptick in open interest results from direction-agnostic arbitrage strategies, which involve buying bitcoin in the spot market against a sell position in the futures market. The strategy seeks to profit from the futures premium, which evaporates as expiry nears and converges with the spot price on the day of the settlement, making relatively low-risk returns for the carry trader.
However, the regular cash-and-carry strategy has lost its shine with premiums in single-digits or negative (backwardation) compared with the record 40% basis in mid-April.
Some traders anticipating a bullish revival and a rise in the futures premium may have employed a "reverse cash-and-carry" strategy by selling bitcoin in the spot market against a long futures position.
"Increased reverse cash-and-carry positions could have lifted open interest, but I doubt that it's the primary driver," Rahul Rai, managing partner at Gamma Point Capital, said. "So overall, it looks like there's decent short interest at these levels." Gamma Point Capital runs a market-neutral fund.
LedgerPrime's Tang said reverse cash-and-carry strategies appear quite unattractive with annualized premiums in single digits. Further, Tang pointed to low bitcoin borrowing rates offered by lending-borrowing protocols as evidence of weak demand to borrow bitcoin and short against a long position in the futures market.
All things considered, the futures market is mainly biased bearish, which leaves the door open for sharp corrective rallies in bitcoin's price. When leverage is skewed to the bearish side, a move higher often results in forced closure of short positions (exchanges square off shorts). That, in turn, puts upward pressure on the cryptocurrency's price, leading to exaggerated price moves. "A rally up could cause them to get liquidated," Rai said.
Bitcoin is currently trading at $31,400, representing a 5% gain on the day.
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