Bitcoin prices are again capturing headlines, soaring to a new record of $72,134 on Monday morning. Alongside these record prices comes increased volatility. Just last week, on March 5, we witnessed a sharp 15% fall in Bitcoin prices within merely 5 hours, and on January 11, there was a 21% decrease spread over 12 days. A notable commonality in these instances was the presence of high funding rates.
What are funding rates?
Funding rates in the cryptocurrency market are analogous to rollover or swap rates in Forex trading, where brokers lend funds to traders for leveraging positions. In the crypto realm, buyers of Bitcoin futures contracts must compensate the sellers to keep the futures price closely aligned with the Bitcoin spot price. A surge in buyers over sellers drives the funding rate up, sometimes significantly requiring buyers to pay more.
Funding rates today
Currently, the annual funding rate for purchasing Bitcoin futures stands at an astonishing 121%. This implies that for a position held open throughout the year, with the funding rate constant, Bitcoin would need to appreciate by at least 121% just for the buyer to break even. While not impossible, this scenario grows increasingly improbable over time. For instance, between August 2011 and February 2024, Bitcoin's compounded annual growth rate stood at 105%, indicating that exceptionally high funding rates may not be sustainable and could result in losses.
Losses were exactly what we saw last week. Bitcoin may have dropped 15%, but many altcoins, such as Dogecoin, dropped by roughly 35%. With the funding rate at 121% in BTC today, 120% for ETH, 141% for Sol, and 129% for Dogecoin, there is an overwhelming risk that we could experience yet another selloff.
How long can the funding rate remain high without a selloff?
As annual funding rates lift above 100%, we need to be ready for a selloff, and the longer prices stay stagnant, the more dangerous it becomes. There is no clear rule to what is too long, but more than 1 to 3 weeks of high interest seems to be enough for buyers to give up.
At the largest exchange, a 2020 report showed that 55% of its clients used margin products with leverage of 60x or higher. That would imply that these users would only set aside collateral of 1.6% of the notional position size. If we assume that they have a buffer of 2 times this, then that would mean equity of 3.3%. If people still trade with the same leverage and equity ratios in 2024, then with today's rates, the cost to hold a Bitcoin position for a week is 2.22%; hence, most traders will lose all their equity in 10.5 days and receive margin calls within seven days.
How to deal with high funding rates
A simple strategy for short-term and swing traders is to reduce exposure when funding rates are too high to lock in gains and have cash ready to potentially benefit on dips.
Plotting levels anywhere from -10% to -30% in BTCUSD and -50% for alt-coins is standard practice.
In general, when the pain is greatest in BTC and ETH, we tend to see the rest of the market turn higher.
Funding rates will drop as we have selloffs, but the initial reaction of speculators is to buy more futures on the decline, which means that it can take 24 hours for the funding rate to drop back below 50%. Hence, the big shift in funding rates will usually be visible 24 hours after the selloff. At that point, if funding is below 50% and closer to 30% on an annual basis, bitcoin prices tend to regain their footing.
Another common practice is paying extra attention to key support levels in the 4-hour chart, as what could look like a harmless end to a short-term trend could lead to an even more significant drop.
As usual, it is essential to remember that any type of trading is risky, but Cryptocurrency trading brings its own challenges. Hence, trading with money we can afford to lose comes to its head with cryptocurrency trading.
Will Bitcoin continue its surge or is a decline inevitable due to high funding rates? Log in to ThinkPortal to trade your view!
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