Bitcoin's Derivative Data Suggests Potential for 'Short Squeeze'

A minor increase in price could send short sellers scrambling to close their bets.

AccessTimeIconApr 27, 2022 at 10:31 a.m. UTC
Updated Apr 27, 2022 at 1:56 p.m. UTC

Omkar Godbole was a senior reporter on CoinDesk's Markets team.

Macro traders expecting a continued decline in bitcoin (BTC) should look at the positioning in the derivatives market, or otherwise they risk being caught off guard by a potential short squeeze, which is a rapid move higher driven by bears abandoning their bearish bets.

For a short squeeze to occur, the market needs to have a higher-than-usual bearish activity. In such situations, a minor price bump can send bears or short sellers running to square off their positions, which, in turn, drives prices further up.

Open interest, or the number of open positions in bitcoin's perpetual futures market, rose to 256,752 BTC early this week, the second-highest daily tally in 365 days, surpassed. only by Jan. 4's total of 260,000 BTC, data provided by Arcane Research shows.

Most of these could be short positions, as data tracked by Laevitas shows the funding rate – the cost of holding long/short perpetual futures positions – has been consistently neutral to negative in recent weeks. A negative funding rate means shorts are paying longs to keep the bearish position open. In other words, the market is skewed bearish. That's also evident from the depressed futures premium, also known as the basis, on major exchanges, including the Chicago Mercantile Exchange, a proxy for institutional activity. The three-month premium recently slipped to 1.1% annualized on the CME and 2% on Binance, the world's largest crypto exchange by open interest and volume.

So, now if bitcoin turns higher, the cost of holding shorts will become a burden for traders holding bearish positions. And they could offload their bearish bets, putting upward pressure on prices. Bitcoin was last seen trading near 2% higher on the day near $38,900, according to CoinDesk data.

"All [open interest] growth in late April has been accompanied by substantially negative funding rates, suggesting that shorts are the key aggressor while also implying some capitulation from longs after this leg downward," Arcane Research's Vetle Lunde wrote in a weekly research report shared with CoinDesk on Tuesday.

"The sentiment, funding rates and futures basis [premium] suggest that shorts are the most confident. Thus, a short squeeze is possibly on the table," Lunde added.

CoinDesk - Unknown

Bitcoin dominated open interest in perpetual futures and futures (Arcane Research)

While open interest in perpetual futures has increased, the number of open positions in regular futures remains depressed. Perpetual futures differ from regular futures as they lack predetermined expiry. So, perpetual futures positions can be held indefinitely without the need to square off or roll over positions ahead of the expiration date.

Open interest as a standalone indicator reveals only the amount of fiat money locked in the derivatives market. However, when combined with other metrics like the funding rate – the cost of holding long/short perpetual futures positions – analysts get an idea about the nature of the positioning.

DISCLOSURE

Please note that our privacy policy, terms of use, cookies, and do not sell my personal information has been updated.

The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups. As part of their compensation, certain CoinDesk employees, including editorial employees, may receive exposure to DCG equity in the form of stock appreciation rights, which vest over a multi-year period. CoinDesk journalists are not allowed to purchase stock outright in DCG.

CoinDesk - Unknown

Omkar Godbole was a senior reporter on CoinDesk's Markets team.

CoinDesk - Unknown

Omkar Godbole was a senior reporter on CoinDesk's Markets team.

Trending

1
CoinDesk - Unknown
First Mover Asia: Remember ICOs? You Would Have Made a Fortune if You HODLed; Bitcoin Slogs Toward $20K

Investors who purchased a breadbasket of blue chip coin offerings about five years ago would have generated an 819% return, even with the current bear market; most cryptos fell in Tuesday trading.

CoinDesk - Unknown
2
CoinDesk - Unknown
Compass Mining Seen Losing Maine Facility After Failing to Pay Power Bill

The most valuable crypto stories for Tuesday, June 28, 2022.

CoinDesk - Unknown
3
CoinDesk - Unknown
Crypto Jobs: Who’s Cutting and Hiring?

A running reckoning to layoffs and hirings in the cryptocurrency/blockchain industry.

CoinDesk - Unknown
4
CoinDesk - Unknown
Governments May Restrict Foreign Access to Their CBDCs, Riksbank Official Says

Not all countries “play nicely” with each other, complicating how central bank digital currencies will interact with other payment systems, said Cecilia Skingsley, first deputy governor at the Swedish central bank.

CoinDesk - Unknown