A measure of leverage in the Bitcoin market just fell to its lowest since late 2021, a sign that volatility inducing speculators are increasingly being washed out of the market, meaning that the world’s largest cryptocurrency by market capitalization may be in for calmer waters ahead.
Crypto analytics firm CryptoQuant’s “Estimated Leverage Ratio” (ELR) just fell to 0.195, its lowest since December 2021.
That’s down from a peak of 0.4 just before the collapse of cryptocurrency exchange FTX last November, which was the catalyst for Bitcoin hitting its 2022 bear market lows in the $15,000s.
CryptoQuant calculates its ELR by dividing the dollar value of open perpetual Bitcoin future contract positions by the number of Bitcoin tokens being held by derivatives exchanges (where traders open those perpetual Bitcoin future positions).
A lower number means that traders on derivatives exchanges are opening less leveraged positions proportional to the number of tokens they have on the exchange, essentially implying there is less speculation in the market.
Lower Leverage Could Be Bullish for Bitcoin
As can be seen above, the relationship between CryptoQuant’s ELR and the BTC price is weak.
When Bitcoin was at record highs in late-2021, the ELR was around current levels, before the ELR then peaked when the Bitcoin price was around the $20,000 mark.
But a lower ELR could nonetheless still be bullish for the Bitcoin price, as when the market gets excessively leveraged, this can trigger volatility (as positions are stopped out).
Higher volatility can deter investors. A lower volatility profile ahead could be a key factor in attracting new retail and institutional investors to the space.
The drop in the ELR comes after wild liquidation-induced swings in the Bitcoin price on Wednesday.
And lower volatility ahead seems to be just what investors are expecting, according to Bitcoin options market pricing.
Implied volatility according to At-The-Money (ATM) Bitcoin options expiring in 7, 30, 90 and 180 days are all in the 45-55% range, which is close to historic lows.
Dominant derivative exchange Deribit’s Bitcoin Volatility Index (DVOL) is also near historic lows at current levels around 55.
Alternative metrics of leverage in the Bitcoin market have also been in decline.
The ratio of the dollar value of open interest in the Bitcoin futures market to Bitcoin’s market capitalization was last around 0.0176.
That’s according to data from The Block, which showed open interest in Bitcoin futures at around $9.7 billion on Wednesday versus Bitcoin’s closing market cap of around $550 billion.
On the first of November 2022, when Bitcoin’s closing market cap was just over $393 billion and future open interest was around $11.56 billion, this ratio was at a much higher level of close to 0.03.
The washing out of speculators and Bitcoin “tourists” has historically been consistent with the market finding a low and then proceeding to recover, before price momentum-related FOMO (fear of missing out) then attracts a new wave of speculators and “tourists”.
That’s why on-chain analysts like to monitor metrics such as Realized HODL Ratio, which captures the balance between BTC wealth held in 1-week old coins versus 1-2 year old coins.
As can be seen in the above chart presented by crypto analytics firm Glassnode, this ratio tends to bottom in line with bear market bottoms, indicating that weaker conviction speculators and tourists have been wiped out and a higher proportion of high conviction longer-term HODLers remain.
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The Bitcoin (BTC) market has seen a declining trend in overall leverage, which is a good indicator for the cryptocurrency’s price. Though speculative money has become a significant part of the Bitcoin (BTC) market over the past few years, it looks like the enthusiasm is beginning to wane. According to data from Bybt, open interest (OI) for the cryptocurrency has dropped by 5.5 percent since the beginning of the year, going from about $2.1 billion to $2.0 billion. The decline in leverage is a sign that certain investors may be cooling off their enthusiasm for the crypto asset, which is actually bullish for the Bitcoin price in the long term.
The primary reason why a decline in speculative money is bullish for Bitcoin is that it reduces overall market volatility. Over the past few years, the cryptocurrency has been known for its wild swings in price, which can be attributed to speculators and traders levering up their positions to drive up the price or short-sell it. When these investors withdraw their capital, the market is less influenced by them and therefore less volatile. This leads to a more mature market, where investors are buying Bitcoin for its long-term value instead of “trading it” for short-term gains.
The second reason why a decline in leverage is good news for the Bitcoin market is that it signals a shift from pure speculation to long-term investment. Many traders have been riding the waves of Bitcoin’s bull and bear markets, looking to cash in quick profits. As these traders pull back, more institutional and long-term investors are likely entering the market. This is a sign that Bitcoin is growing more mature and becoming a legitimate asset for large investors, which is bullish for the overall market.
Overall, a declining trend in leverage is a positive signal for the Bitcoin market. It suggests that the cryptocurrency is maturing, with more investors shifting from short-term trading to a long-term outlook. This could lead to increased stability in the markets and higher prices in the near future. As Bitcoin continues to evolve as an asset, it’s likely that more investors will enter the cryptocurrency space and take it mainstream.
