Crypto Leverage vs. ETF Resilience: Bitcoin’s Wild Ride

According to analysis from
JPMorgan Chase, the recent downturn affecting
Bitcoin (BTC) and
Ethereum (ETH) prices was primarily driven by excessive leverage within the cryptocurrency market itself, rather than large-scale withdrawals from institutional investors.
Their findings suggest that spot Bitcoin ETFs and CME futures exhibited limited forced selling, while significant deleveraging occurred in perpetual futures markets for both cryptocurrencies.

Between October 3rd and October 17th, Bitcoin’s value decreased by 13.1%, dropping from $122,316 to $106,329. Simultaneously, open interest in perpetual futures contracts saw a substantial decline, falling from approximately $70 billion to $58 billion
around October 10th. This $12 billion reduction implies forced liquidations resulting from leveraged positions being unwound.

Data from
Farside Investors indicates that Bitcoin spot ETFs experienced
net outflows of $70.4 million, mainly concentrated on October 14th, 15th, and 16th. These outflows are comparatively small relative to the overall price decrease and the extent of leverage reduction in the derivatives market.

Ethereum experienced even greater deleveraging relative to its total market capitalization. Open interest in its perpetual futures market plunged from roughly $28 billion to a range of $19 billion to $20 billion on October 10th, a decline of $9 billion to $10 billion.

Ethereum spot ETFs reported
net outflows of $668.9 million across October 9th, 10th, 13th, and 16th, which is about 9.5 times larger than the outflow seen in Bitcoin ETFs, with redemptions peaking on October 10th and 13th.

Despite the larger response in Ethereum ETFs, JPMorgan’s analysis suggests that the primary driver behind price movements in both Bitcoin and Ethereum was deleveraging in perpetual futures markets. The ETF flows displayed a significantly smaller indication of “forced selling” compared to the cascading effects observed in the derivatives sector.

The data supports JPMorgan’s conclusion. Ethereum’s open interest experienced a roughly 35% decline, while Bitcoin’s decreased by about 17%. Both assets exhibited a synchronized sell-off on October 10th as leverage was reduced across various cryptocurrency platforms.

Perpetual Flush Mechanics Explained

Perpetual futures contracts can magnify price fluctuations due to the leverage they provide. When prices decline rapidly, traders using high leverage may face margin calls. If they are unable to meet these calls, exchanges will automatically liquidate their positions at market prices. This selling pressure, combined with limited liquidity, can create a self-reinforcing downward spiral.

Cross-margin trading further complicates the situation. As the value of assets held as collateral decreases during a price downturn, the overall margin available to traders shrinks. This can trigger further liquidations, even for accounts that initially appeared adequately funded.

Funding rates offer an early indication of market sentiment. During a rapid price decline, funding rates for perpetual futures typically turn negative, meaning that traders holding short positions are paid by those holding long positions. This indicates strong bearish sentiment.

A recovery may begin when funding rates start to normalize towards zero, and the price difference between perpetual futures and the spot market narrows. Ideally, price stabilization should be driven by increased trading volume in the spot market, rather than solely by activity in the perpetual futures market.

Open interest is another key indicator. A significant decrease in aggregate open interest alongside a sell-off indicates that traders are exiting the market entirely, rather than simply shifting their positions from long to short.

The 17% decline in Bitcoin’s open interest and the 35% decline in Ethereum’s open interest both suggest genuine deleveraging occurred during the recent price drop.

A healthy market recovery typically involves a gradual increase in prices, led by activity in the spot market. Open interest should increase modestly, funding rates should remain close to zero, and the difference between perpetual futures and spot prices should remain minimal.

A sustainable bottom after a perpetual flush is characterized by negative funding rates moving back toward zero, a shrinking difference between the perpetual price and spot price, a slow rebuilding of open interest, and a futures curve returning to a slight contango (where futures prices are higher than spot prices).