The use of Bitcoin (BTC) as collateral for cryptocurrency futures trading has surged in recent months, reaching 33% of the total futures open interest, up from 20% in July, according to data from Glassnode. While cash or stablecoin-margined contracts still constitute 65% of the total open interest, the rise in BTC-margined contracts raises concerns about increased volatility and potential liquidation cascades.
Futures trading allows traders to maximize exposure with a small deposit, known as margin, which is a fraction of the contract size. The exchange provides the rest of the trade’s value. The renewed interest in BTC-margined contracts introduces the potential for volatile liquidation cascades, where multiple forced position closures occur consecutively, leading to rapid price changes.
Using BTC as collateral for BTC derivatives is described as a “double whammy” by analysts at Blockware Intelligence. If a trader holds a long BTC position with BTC as collateral, a declining BTC price can quickly bring them to their liquidation point because the value of their collateral is also decreasing simultaneously. Leveraging BTC during its monetization phase is considered highly risky, as volatility can lead to significant losses regardless of the trader’s directional accuracy.
Coin-margined contracts are quoted in US dollars but margined and settled in cryptocurrencies, resulting in collateral that is as volatile as the underlying position. This setup creates a non-linear payoff structure, where traders earn less when the market rallies and lose more when it drops. Consequently, long positions can suffer losses both from Bitcoin’s declining dollar-denominated price and the decreasing value of their collateral, potentially leading to rapid margin shortfalls and liquidations.
The trend of increasing coin-margined contracts raises concerns about the potential for frequent volatility-boosting liquidation cascades. Such events were common before September 2021 when coin-margined contracts accounted for over 50% of the global open interest. This renewed interest in these contracts may indicate a shortage of cash in the market as traders turn to leveraging their BTC holdings to increase their exposure.
Overall, the growing use of BTC as collateral in futures trading adds an additional layer of complexity to cryptocurrency markets, increasing the potential for rapid price movements and liquidations. Traders must navigate this evolving landscape with caution, considering the added risks associated with coin-margined contracts.