DeFi Jitters, ETF Calm

Financial analysis by
JPMorgan suggests the recent downturn in
Bitcoin (BTC) and
Ethereum (ETH) prices originated from high leverage within the crypto market itself, not significant withdrawals by institutional investors. Their assessment indicates that spot ETFs and CME futures showed resilience, absorbing minimal forced selling, while the perpetual futures market experienced considerable deleveraging for both cryptocurrencies.

Bitcoin’s value decreased by 13.1%, moving from $122,316 on October 3rd to $106,329 by October 17th. Concurrently, open interest in perpetual futures contracts diminished from around $70 billion to $58 billion
around October 10th. This $12 billion contraction points to forced liquidations rather than planned exits.

Data provided by
Farside Investors reveals that Bitcoin spot ETFs experienced
net outflows of $70.4 million, primarily between October 14th and 16th. This figure is relatively small when compared to the overall price movement and the massive leverage reduction seen in the derivatives markets.

Ethereum’s deleveraging was even more pronounced relative to its market size. Open interest in its perpetual futures market declined sharply, going from approximately $28 billion to a range of $19 billion to $20 billion around October 10th – a reduction of $9 billion to $10 billion.

Ethereum spot ETFs registered
$668.9 million in net outflows across October 9th, 10th, 13th, and 16th. This is about 9.5 times the outflow observed in Bitcoin ETFs, with the largest redemptions occurring on October 10th and 13th.

Despite the larger institutional activity observed in Ethereum ETFs, JPMorgan concluded that deleveraging in perpetual futures played a dominant role in the price fluctuations of both Bitcoin and Ethereum. They suggest that ETF flows demonstrated “little forced selling” compared to the cascading effect observed in the derivatives market.

The data supports the firm’s argument. Open interest in Ethereum dropped by about 35%, while Bitcoin’s fell by roughly 17%. However, both digital assets experienced a simultaneous sell-off on October 10th as leverage was unwound across various crypto trading platforms.

Perpetual Flush Mechanics

Perpetual futures contracts tend to amplify price movements due to the use of leverage. When prices decline rapidly, margin ratios are affected, leading exchanges to liquidate positions with insufficient margin. These liquidations are executed with market orders, which can exacerbate price declines, particularly when order books are thin, triggering a series of cascading liquidations.

Cross-margin trading further intensifies this effect. As the value of the underlying asset falls, the collateral used for margin also decreases. This can push accounts that initially appeared safe below the maintenance margin threshold, forcing additional liquidations and further fueling the downward price spiral.

Funding rates provide an early indicator of market sentiment. During a significant downward movement, perpetual futures typically exhibit sustained negative funding rates, meaning that the perpetual contract trades at a discount relative to the spot index price.

A recovery begins when funding rates gradually move back towards zero, and the premium or discount of the perpetual contract narrows. Ideally, price stabilization should be accompanied by increased trading volume in the spot market rather than solely driven by activity in the perpetual futures market.

Open interest is another crucial factor. A substantial decrease in aggregate open interest alongside a sell-off indicates that leverage has been removed from the system, rather than simply being reallocated to new short positions.

The observed 17% decrease in Bitcoin’s open interest and the 35% decrease in Ethereum’s open interest both suggest genuine deleveraging within the cryptocurrency markets.

A healthy recovery is typically gradual and driven by spot market activity. Prices may rebound or stabilize while open interest gradually increases. Funding rates remain near zero, and the relationship between the perpetual contract and the spot price remains relatively tight.

A sustainable bottom following a perpetual flush is characterized by negative funding rates moving back toward zero, a reduction in the discount of the perpetual contract, a reset and gradual rebuilding of open interest, and a slight upward slope (contango) in the futures curve.