Bitcoin's 4% Drop Cools Overheated Funding Rates, Data Show

Bitcoin (BTC) fell early Monday, validating the caution signaled by the options market last week.

The 4% drop to $42,000 has cooled the overheated crypto perpetual futures market, clearing the way for a steady ascent into the year-end.

Perpetuals are futures with no expiry with a funding rate mechanism that helps tether perpetual prices to the index price. Funding rates are periodic payments of an asset between long (buy) and short (sell) position holders calculated and collected by exchanges every eight hours. A positive funding rate means the perpetual contract is trading at a premium to the spot prices; longs are dominant and are paying shorts to keep their positions open. A negative rate suggests otherwise.

A high funding rate, typically greater than 0.10% (for eight hours), is taken to represent excess bullish leverage or overcrowding of long positions.

According to data source Velo Data, funding rates for BTC, ETH and other major cryptocurrencies consistently tapped the 0.15% mark in the second half of last week, signifying an overheated leveraged market.

The situation has normalized with the early Asian session market-wide price drop, leaving funding rates for most coins in a healthy territory below 0.1%.

It's a sign overleveraged traders have been shaken out of the market. Funding rates or costs associated with leverage become a burden when the momentum stalls, forcing overleveraged traders to exit and causing a minor bullish/bearish hiccup.

The market-wide decline in the notional open interest, or the dollar value locked in open crypto futures contracts, suggests the same. As of writing, XLM, UNI, LINK and XMR showed a double-digit slide in open interest for the past 24 hours.

Open interest in bitcoin and ether was down 1.3% and 6.7%, respectively.