3 Reasons Bitcoin’s Fall to $21,000 and Market-Wide Selloff May Be Worse Than You Think

Friday 19 In August, the total crypto market value fell by 9.1%, but more importantly, the important psychological support of $1 trillion was used. The market’s last venture below this was just three weeks ago, meaning investors were pretty sure that the June 18 market cap low of $780 billion was just a distant memory.

Regulatory uncertainty rose on August 17 after the US House Committee on Energy and Commerce announced it was “deeply concerned” that proof-of-work mining could increase demand for fossil fuels. As a result, US lawmakers asked crypto mining companies to provide information on energy consumption and average costs.

Usually, sell-offs have a bigger impact on cryptocurrencies outside the top 5 assets by market capitalization, but today’s correction saw losses ranging from 7% to 14% across the board. Bitcoin (BTC) saw a 9.7% loss as it tested $21,260 and Ether (ETH) presented a 10.6% drop at its intraday low of $1,675.

Some analysts might suggest that harsh daily corrections like the one we’re seeing today are the norm rather than the exception given the asset’s 67% annual volatility. For example, today’s intraday drop in total market capitalization exceeded 9% in 19 days over the past 365, but a few detractors make this current correction stand out.

BTC Futures premium disappeared

The fixed-month futures contracts typically trade at a slight premium to regular spot markets because sellers require more money to hold back settlement for longer. Technically known as “contango”, this situation is not exclusive to crypto assets.

In healthy markets, futures should trade at an annual premium of 4% to 8%, which is enough to compensate for the risk plus the cost of capital.

According to OKX and Deribit Bitcoin futures premium, the negative swing of 9.7% on BTC caused investors to eliminate all optimism by using derivative instruments. When the indicator turns to the negative area, trading in “backwardation”, it usually means that there is much higher demand from leveraged shorts betting on further downside.

Mortgage buyers’ liquidations exceeded $470 million

Futures contracts are a relatively inexpensive and simple instrument that allows the use of leverage. The danger of using them lies in liquidation, which means that the investor’s margin deposits become insufficient to cover their positions. In these cases, the exchange’s automatic gearing mechanism kicks in and sells the crypto used as collateral to reduce exposure.

A trader can increase the profit by 10 times using leverage, but if the asset falls 9% from the entry point, the position is closed. The derivatives exchange will continue to sell the security, creating a negative loop known as a cascade liquidation. As shown above, the August 19 sale saw the highest number of buyers forced to sell since June 12.

Margin traders were excessively bullish and broke

Margin trading allows investors to borrow cryptocurrency to leverage their trading position and potentially increase returns. As an example, a trader can buy Bitcoin by borrowing Tether (USDT), thereby increasing their crypto exposure. On the other hand, borrowing Bitcoin can only be used to short it.

Unlike futures contracts, the balance between margin longs and shorts is not necessarily matched. When the margin lending ratio is high, it indicates that the market is bullish – the opposite, a low ratio, signals that the market is bearish.

Crypto traders are known to be bullish, which is understandable given the adoption potential and rapidly growing use cases such as decentralized finance (DeFi) and the perception that certain cryptocurrencies provide protection against USD inflation. A lending margin rate of 17 times higher favoring stablecoins is not normal and indicates excessive confidence from leverage buyers.

These three derivatives calculations show that traders definitely did not expect the entire crypto market to correct as strongly as today, nor for the total market cap to retest the $1 trillion support. This renewed loss of confidence could cause bulls to reduce their leverage positions further and possibly trigger new lows in the coming weeks.

The views and opinions expressed herein are solely those of author and do not necessarily reflect the views of Cointelegraph. Every investment and trade involves risk. You should do your own research when making a decision.