On August 19, the total cryptocurrency market cap fell by 9.1%. But most importantly, the trillion-dollar psychological support has been tapped. The latest project to market lower than this just three weeks ago, which means investors were pretty confident that the total low market capitalization of $780 billion on June 18 was just a distant memory.
Regulatory uncertainty increased on August 17 after the US House Committee on Energy and Commerce said it was “deeply concerned” that proof-of-work mining could increase demand for fossil fuels. As a result, US lawmakers have asked crypto mining companies to provide information on energy consumption and average costs.
Selling off usually has a bigger impact on cryptocurrencies outside of the top five assets by market cap, but the correction on August 20 resulted in losses ranging from 7% to 14% across the board. Bitcoin (BTC) saw a 9.7% loss as it tested $21,260, while Ether (ETH) delivered a 10.6% drop at its daily low of $1,675.
Some analysts might suggest that severe daily corrections like the one seen on August 20 are the rule rather than the exception, given the asset’s 67% annual volatility. Case in point, the August 20 daily decline in total market capitalization exceeded 9% in 19 days over the past 365 days, but some aggravating factors caused this current correction to appear.
BTC Futures Bonus Disappeared
Fixed month futures contracts usually trade at a slight premium to the regular spot markets because sellers demand more money to withhold settlement for a longer period. Technically known as “contango,” this mode is not limited to crypto assets.
In healthy markets, futures contracts should trade at an annual premium of 4% to 8%, which is enough to offset the risk plus the cost of capital.
Annuity for 3-month Bitcoin futures contract. Source: Laevitas
According to the premium for OKX and Deribit Bitcoin futures, a negative 9.7% swing on BTC has wiped out any optimism with derivatives instruments. When the indicator turns into negative territory, and is trading “down”, it usually means that there is much higher demand for leveraged short positions, which are betting on further declines.
Leverage Buyer Liquidations Exceeded $470 Million
Futures contracts are an easy and relatively low cost instrument that allows the use of leverage. The risk of using them is liquidation, which means that the investor’s margin deposit becomes insufficient to cover their positions. In these cases, an automatic de-leveraging mechanism is initiated by the exchange and the cryptocurrency used as collateral is sold to reduce exposure.
24 hour total cryptocurrency liquidations, in USD. Source: Coinglass
A trader may increase their gains by 10x using leverage, but if the asset falls 9% from the entry point, the position is terminated. The derivatives exchange will initiate the sale of the security, creating a negative cycle known as cascading liquidation. As shown above, August 19 short selling provided the largest number of buyers forced to sell since June 12.
Margin traders were overly optimistic and destructive
Margin trading allows investors to borrow cryptocurrencies to take advantage of their trading position and increase their returns. For example, a trader can buy Bitcoin by borrowing Tether (USDT), thus increasing his exposure to the cryptocurrency. On the other hand, borrowing Bitcoin can only be used to sell it short.
Unlike futures, the balance between long positions and margin is not necessarily the same. When the margin lending ratio is high, this indicates that the market is bullish – and vice versa, a low ratio indicates that the market is bearish.
OKX USDT/BTC Margin Lending Ratio. Source: OKX
Cryptocurrency traders are known to be bullies, which is understandable given the potential for adoption, fast-growing use cases such as Decentralized Finance (DeFi) and the perception that some cryptocurrencies offer protection against the inflation of the US dollar. Margin lending rate of 17x in favor of stablecoins is not normal and indicates excessive confidence from leverage buyers.
These three derivative measures show that traders were certainly not expecting the entire crypto market to correct as sharply as today, nor for the total market cap to retest the trillion-dollar support. This renewed loss of confidence could cause the bulls to reduce their leverage positions and possibly launch new lows in the coming weeks.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading movement involves risks. You should do your research when making a decision.