Why does Bitcoin see extreme price movements?

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Nearly $ 1 billion worth of Bitcoin (BTC) futures contracts were liquidated on January 13, the day after the big cleanup. The continuous liquidation loop leads to extreme volatility and large price fluctuations in the cryptocurrency market.

Total Bitcoin liquidations. Source: Bybt.com

What are futures liquidations and why are so many bitcoin positions being liquidated?

In the Bitcoin futures market, traders borrow additional capital to bet against or for Bitcoin. The technical term for this is leverage, and when traders use high leverage, the liquidation threshold becomes tighter.

For example, if a trader borrows 10 times the initial capital, a 10% price movement in the opposite direction would result in the position being liquidated. Once liquidated, the position becomes worthless and all of the initial capital is lost.

When Bitcoin saw a sharp 20% drop from $ 41,000 to $ 30,500 on Jan. 12, futures contracts worth nearly $ 2 billion were liquidated.

However, within 24 hours, additional contracts worth $ 1 billion were liquidated. However, there wasn’t much price fluctuation other than the range between $ 32,000 and $ 35,500.

The data shows that many traders overfunded their positions to sell BTC after recovering from $ 30,500. When Bitcoin rose to $ 35,500, many short contracts were liquidated.

The cascading liquidations of short contracts are most likely the main reason for BTC’s quick 20% relief rally from $ 30,500 to $ 35,500.

The market is less leveraged compared to the last two weeks. The futures funding rate hovers between 0.01% and 0.05%, which means buyers still represent the majority of the market but not dominate the market.

By comparison, when Bitcoin was above $ 40,000, the futures funding rate stayed constant at around 0.1% to 0.15%. This meant that the market was overwhelmed by buyers and overfunded dealers.

“Healthy” shakeout

While extreme volatility is not cheap, cleaning up an overfunded market is healthy and essential for the rally to continue.

If the Bitcoin market continues to remain extremely overfunded on a rally above $ 40,000, it risks a correction much larger than 25%.

In previous bull markets, Bitcoin has seen declines of 30% to 40% frequently, and so the recent drop from $ 42,000 to almost $ 30,000 is nothing out of the ordinary for a BTC bull market.

As the pseudonymous trader “Byzantine General” noted, the $ 30,000 area has become an important level of support.

The cooling of the Bitcoin futures market while consolidating USD 30,000 as a support area is extremely optimistic for the medium-term outlook for BTC.

Whale clusters also identify the $ 30,000 level as support for whale clusters, meaning that psychological level will certainly be defended by the cops if the price turns south.