Bitcoin Futures Open Interest Surges: A Red Flag for BTC Price?

Bitcoin has reached a new milestone, surpassing $72,000 for the first time ever on March 11. This marks a 9.5% increase in the past week. The rally has been volatile, with a 4.8% rise to $70,055 on March 8 followed by a 5.9% dip to $65,935. As a result, Bitcoin bulls are cautious about celebrating this all-time high, especially considering the surge in demand for leveraged positions through BTC futures contracts.

Analysts have noted that the $35.8 billion in Bitcoin futures open interest poses a risk, as traders often rely too heavily on leverage. While this level of interest confirms investor attraction, it doesn’t necessarily imply a bullish sentiment because futures longs (buyers) and sellers (shorts) are always matched, creating volatility rather than a clear direction.

It’s worth mentioning that the Chicago Mercantile Exchange (CME) currently holds the largest share in Bitcoin futures, surpassing popular crypto exchanges like Binance, Bybit, and OKX. This was not the case in November 2021 when Bitcoin futures open interest peaked, leading to a 31.5% decline in just one month as BTC traded near $69,000. In BTC terms, the open interest remains 27% below its peak in October 2022. The current 495,380 BTC in futures open interest is significant enough to trigger sharp volatility spikes as Bitcoin’s price fluctuates, as seen on March 4 when $325 million in leveraged BTC positions were liquidated.

To determine whether leverage demand is mainly for buying, we can examine Bitcoin’s futures monthly contracts. These contracts typically trade at a slightly higher price than the spot markets due to sellers asking for more money to delay settlement. BTC futures ideally trade at a premium of 5 to 10% annually, known as contango, which is common in financial markets. Recent data shows a surge in demand for leveraged BTC long positions, with the premium surpassing the 10% neutral mark four weeks ago and peaking at 23% recently, the highest in over 18 months. This current 21% level often indicates excessive optimism. Considering Bitcoin’s 40% price surge in the last two weeks, it’s premature to deem the current futures premium unsustainable, especially when historical bull markets saw premiums exceed 45%.

On March 11, the funding rate for Bitcoin futures perpetual contracts hit 2.1% per week, the highest in over 18 months. Retail traders typically favor these contracts for their close tracking of spot market prices, but they come with a variable leverage fee called the funding rate. A positive rate suggests that traders heavily rely on leverage for their long positions. Bitcoin bulls benefit from strong inflows into spot exchange-traded funds (ETFs), and Microstrategy continues to buy more Bitcoin despite the high prices. If retail traders start pouring into these expensive perpetual contracts at $72,000, market makers and arbitrage desks may exploit the over-leveraged positions and create volatility. While a few big players may not have a lasting impact on Bitcoin’s price, the risk of a domino effect of liquidations increases if there’s a price dip and investors have to pay a 2.1% fee every week to maintain their bullish bets.

Although the leverage scenario raises concerns, steady ETF inflows suggest it may be premature to predict a major price drop solely based on this factor.