Bitcoin’s recent rally to new all-time highs has been fueled by a surge of bullish bets in the futures market, but the cost of maintaining these positions has also reached unprecedented levels.
Funding rates are periodic payments made by traders based on the difference between the prices of perpetual futures contracts and the spot market. Perpetual futures are a type of derivative that have no expiry date and mimic the price of the underlying asset. They are popular among crypto traders because they allow them to use leverage, or borrowed funds, to amplify their gains or losses.
A positive funding rate means that the perpetual futures are trading at a premium to the spot price, indicating that the demand for long positions, or bets on a price rise, is higher than the supply of short positions, or bets on a price fall. In this case, longs have to pay shorts a fee to keep their positions open. Conversely, a negative funding rate means that the perpetual futures are trading at a discount to the spot price, indicating that shorts are paying longs.
Funding rates are usually expressed as an annualized percentage and are collected every eight hours by most exchanges. A high funding rate, typically greater than 0.1%, is a sign of excessive bullish leverage or overcrowding of long positions. This can create a risk of a price correction, as traders may be forced to close their positions to avoid paying high fees or getting liquidated by the exchange if the price moves against them.
How high are the funding rates now and what does it mean for the market?
According to Velo Data, funding rates for major cryptocurrencies, including bitcoin, have soared to record levels in the past week, reaching as high as 0.66% on some exchanges. This means that traders are paying an annualized fee of 66% to hold their long positions. This is an unusually high level, as the average funding rate for bitcoin in 2023 was around 0.01%, according to Coindesk.
The spike in funding rates reflects the strong bullish sentiment in the market, as bitcoin broke above $60,000 for the first time in history and reached a new peak of $66,930 on Oct. 20, 2023. The rally was driven by several factors, such as the launch of the first bitcoin exchange-traded fund (ETF) in the U.S., the growing adoption of bitcoin by institutional and retail investors, and the anticipation of more regulatory clarity and innovation in the crypto space.
However, the high funding rates also indicate that the market is overheated and vulnerable to a pullback, as overleveraged traders may face margin calls or liquidations if the price drops. Liquidations refer to when an exchange forcefully closes a trader’s leveraged position due to a partial or total loss of the trader’s initial margin. It happens when a trader is unable to meet the margin requirements for a leveraged position (fails to have sufficient funds to keep the trade open). Large liquidations can signal the local top or bottom of a steep price move.
According to data from Bybt, more than $300 million worth of bullish bets were liquidated on Nov. 15, 2023, as bitcoin fell 4% to $35,600. This was the largest daily liquidation since May 19, 2023, when bitcoin crashed 30% to $30,000 and wiped out more than $8 billion worth of leveraged positions. The liquidations contributed to the downward pressure on the price, as traders had to sell their spot holdings or futures contracts to cover their losses.
What are the implications for the future of bitcoin?
The high funding rates and liquidations show that the crypto market is still dominated by speculative and volatile trading, which can create significant price swings and risks for investors. While some traders may see this as an opportunity to profit from the market movements, others may prefer to avoid the leverage and stick to the spot market, where they can buy and hold bitcoin without paying any fees or facing any liquidation risk.
The high funding rates also suggest that there is room for more innovation and competition in the crypto derivatives market, as traders may seek lower-cost and more efficient ways to gain exposure to bitcoin and other cryptocurrencies. For example, some traders may opt for futures contracts with fixed expiry dates, which do not have funding rates, or options contracts, which give them the right but not the obligation to buy or sell bitcoin at a predetermined price and date. Alternatively, some traders may use decentralized exchanges (DEXs) or peer-to-peer platforms, which allow them to trade directly with other users without intermediaries or centralized control.
Ultimately, the high funding rates and liquidations are a reflection of the growing interest and demand for bitcoin and other cryptocurrencies, as they offer a new and exciting asset class that can potentially transform the global financial system. As the market matures and evolves, traders and investors may find more ways to participate in the crypto revolution with lower costs and higher returns.
