Bitcoin futures trading has been gaining popularity, with BTC-margined contracts now accounting for 33% of total futures open interest, up from 20% in July, according to Glassnode. These contracts offer a non-linear payoff, which means traders reach their position-liquidation point faster than with cash-margined contracts. The rise in BTC-margined contracts has the potential to cause volatility-boosting liquidation cascades, where multiple forced closures of positions due to margin shortage occur consecutively, resulting in rapid price changes.
Increased use of Bitcoin as margin in futures trading
The unpredictable and volatile nature of Bitcoin is unlikely to change as more crypto traders use the cryptocurrency as margin in futures trading. Since July, the percentage of Bitcoin futures open interest margined with Bitcoin has risen to 33% from roughly 20%, while cash or stablecoin-margined contracts still make up 65% of the total open interest.
Futures trading allows traders to maximize their exposure by using margin, which is a small percentage of the contract size. The exchange provides the rest of the value of the trade.
Risks of using BTC as collateral for BTC derivative
Using BTC as collateral for a BTC derivative is risky because if the price of BTC declines, it brings traders to their liquidation point faster as the value of their collateral decreases. Leveraging against BTC during its monetization phase can be extremely risky, as volatility can wipe out traders’ positions regardless of their directional correctness.
Coin-margined contracts are quoted in U.S. dollars but margined and settled in cryptocurrencies. This means that the collateral is as volatile as the position, resulting in a non-linear payoff where traders earn less during market rallies and lose more during market drops.
Concerns about potential volatility and liquidation cascades
The worrying trend is that if coin-margined contracts become dominant, frequent volatility-boosting liquidation cascades may occur. Such events were common before September 2021 when coin-margined contracts accounted for more than 50% of global open interest. This trend suggests a shortage of cash in the market, as traders resort to leveraging against their BTC to increase their exposure.
Liquidity has been leaving the crypto market, with the total market value of all stablecoins contracting by 0.4% to $125 billion in August, marking the 17th consecutive monthly decline. The market cap of tether (USDT), the largest stablecoin by market value, has also fallen by almost $1 billion to $82.87 billion in the past four weeks.
Traders need to be aware of the risks
In conclusion, the increasing interest in BTC-margined futures contracts and the shortage of cash in the market raise concerns about potential volatility and liquidation cascades. Traders need to be aware of the risks associated with leveraging BTC as collateral and the potential for compounding losses due to the volatility of both the position and collateral.
As Bitcoin futures trading continues to grow in popularity, it is essential for traders to understand the risks and potential consequences of using BTC as collateral. By being informed and cautious, traders can make better decisions and potentially avoid the pitfalls associated with this type of trading.
