Photo: Coin Telegraph
The price of Bitcoin dropped sharply from $37,800 to $35,000 overnight, liquidating $572 million worth of cryptocurrency futures positions.
There are three major reasons why the price of Bitcoin declined steeply in the past 12 hours. The reasons are an overheated derivatives market, growing doubt in the market, and the lack of upside volatility.
BTC/USD 15-minute candle chart (Bitstamp). Source: Trading View
Derivatives market was overheated before the correction
Before the pullback occurred, the Bitcoin derivatives market was extremely overheated. The futures funding rate was hovering at around 0.1%, which is 10 times higher than the average 0.01%.
BTC futures perpetual swaps funding rates. Source: Digital Assets Data
The futures funding rate is a mechanism that achieves balance in the futures market by incentivizing long or short contract holders based on market sentiment.
If there are more long contracts or buyers in the market, then the funding rate turns positive. If it becomes positive, then buyers have to compensate short-sellers with a portion of their contracts every eight hours, and vice versa.
Almost all major cryptocurrencies saw their funding rates spike to around 0.1% to 0.3%, which meant the market was extremely overleveraged.
When the market is this overcrowded, the likelihood of a long squeeze increases, which could cause many futures contracts to get liquidated in a short period.
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