Topic: Everything you wanted to know about BTC futures but were afraid to ask! (Read 4051 times)

Interesting development in the futures market.
Future curve in ETH is showing a deep backwardation.

Backwardation happens when shorter expiring futures are trading below spot price, it is the opposite situation of the congango, we have observed many times on the Bitcoin future curve.



From the graph, you can see from the red line that since the beginning of august the curve has begun to exhibit a steep backwardation, i.e. the first contract has begun to trade at a steep discount versus spot price.


One reason for this can be attributed to selling pressure ahead of the merge, expected to happen on September 19th.
Probably a lot of actors, with underlying long positions that cannot be sold, maybe because
locked in staking platforms, or locked  in validators, are hedging against a future price drop.
So, instead of selling their token, they are selling futures and keeping the yielding tokens, so to be neutral against price movements.

This of course adds pressure on the futures markets driving the curve in backwardation.

This interpretation of “real users selling future” is consistent with the particular fact that even if the backwardation is present on every future market, this is more prevalent in unregulated, or “less regulated” ones, leaving the CME behind.





This, coupled with the tiny open interest on the most “tradfi friendly platform”  means that the origin of this shape is not in the financial market betting against the ETH price.

Market Crash Post Mortem
The last Market Dump that happened last friday, was particularly interesting in my opinion. As far as We can see, much of the action can be traced back to the derivatives market.
A few insightful Post mortem were released, I will analyse here, tring to sum them up and add my own consideration and other material I found in different places.
All relevant links are reported at the end of this post and clearly referenced when used.
 
What happened

Last Friday marked accelerated an already weak price action, and bottomed at 42,020 corresponding to a loss of 39% since the ATH observed on November 9th.



The loss is the 2th biggest fall in BTC terms in 2021 only.
If we put in relations the depth of market correction and the time span of the drawdown we see we are in a mixed situation:



 
Anatomy of a crash
 
As noted in the Glassnode report, the catalyst was the break of the support level of 53K on Bitcoin on the back of traditional financial markets weakness. I am not fully confident this is the whole story, but often things happen in the financial markets without a clear trigger, and in the post-mortem analysis we usually agree on what was the cause of the movement, while it would be important to know it before the movement, but this is a different story. Once this level broke a flurry of market longs liquidations led to an astonishing reduction of OI: in a few hours a reduction of $5.4BLN, equivalent to the 25% of the total value.



At 58,202 in BTC terms, this liquidation was the second biggest in history, after the one in May which topped 79,244 BTC



Notably, thi reduction was pretty much evident outside the CME exchange.


The majority of the positions held at the CME are long term ones, as the main customers of this exchange are uber-regulated institutional investors. BITO’s proponents being the biggest of them all holding more than 5,000 futures contracts. Also, the CME being closed helped the poor liquidity of the market, which in turn is one of the reasons why the move took place during a friday night’s lack of liquidity
As the long futures positions were liquidated the funding needed to be paid to keep those positions opened fell sharply. As we have already said in this thread, when the funding is positive, long position holder must pay to keep their position open, while the opposite happens when the funding rate is negative. So, funding rate is a sort of “thermometer” of the imbalance of the future market: when the finding is extreme, this means also positioning is extreme, in one way or the other.
When longs are liquidated, suddenly, all the long retail position gets closed out, so only short position are left in the street so funding turns negative:
 


Funding rate turned to -0.035%, the most extreme level in months.
As you can see, the funding premium has been positive since the beginning of October. Prolonged period of time with positive funding means a high level of confidence by the traders about market bullishness. This confidence can soon turns in complacency, that ignores without taking actions against warning signs of a different market scenario.
Another sign of this complacency has been the continuous outflows from the exchanges:



Typically, users keep their funds at the exchange when they are in immediate need of trading, hence when exchanges see outflows this means users are willing to sell (either against FIAT or vs Altcoins) while when an outflow is observed this means users aren’t keen on selling their fund too soon.
Also, as noted by Coindesk, market participants didn’t see that coming, as the implied volatility for 1m expiry options had been flat since weeks at a tad less than 80%. When the crash occurred the volatility squeezed higher to 98% and steadily declined later when the context of the move was much more clear .
How to get warning signals.
 
Elevated funding rates, coupled with non-decreasing non-CME Open Interest and lack of liquidity on the exchange have signalled a certain stance of complacency in the market. This complacency could have led in one or another direction . As things developed, of course the short leg was the one to benefit. Also given the low liquidity on the exchange, market liquidation mechanism resulted in an accelerator of the movement itself, as liquidity was scarce. This makes an obvious recipe to look for another violent measure: Elevated OI are difficult to maintain, if the funding rate get elevated, as those represent the “cost of taking that position”. So those position must be closed sooner or later, either via a liquidation run, or a bull run, when holder naturally close  their positions.
 
 

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Useful links
 
The Week Onchain (Week 49, 2021)
How Bitcoin Set Itself Up for This Sell-Off
Bitcoin's Saturday sell-off (Paywall)

I am posting here just to make you aware that I opened a "contiguous" thread on the future-based ETF:
Everything you wanted to know about a future Based ETF and were afraid to ask

From now on, I will post there analysis on contango, or other ETF-related mumblings.

The SEC rejecting a physical bitcoin ETF, but approving a cash-settled futures ETF is bureaucracy nonsense. Similarly, allowing the Greyscale investment trust to issue shares that cannot be redeemed, but charges a fee for investors to hold is only going to harm long-term investors.

It would be possible for an issuer to be nearly-guaranteed to match the long-term price of bitcoin (or even beat it by a small amount) if they were to invest in either physical bitcoin or physical-settled bitcoin futures, and were to charge a fee to buy or redeem shares directly to the issuer. The issuer could then not charge a fee to holders of the ETF, and the amount of bitcoin each share represents could remain constant (or even increase, if some of the fee is rebated to the ETF) over time.

I finally managed to replicate that Bitcoin Futures Roll Bleed indicator:



Here you have a zoom on the last year.
I believe that 19% overshoot was an intraday move I am not able to reconstruct.

You see the index has been picking up again, together with the contango season.
I have a suspect this index will shoot again on the next roll when the ETF is actively going to lift that very spread.