Crypto traders’ urge to create leverage positions with Bitcoin (BTC) seems irresistible to many, but it’s impossible to know whether these traders are extreme risk takers or savvy market makers hedging their positions. The need to maintain hedges applies even when traders rely on leverage merely to reduce their counterparty risk by holding a collateral deposit and the bulk of their position in cold wallets.
Not all leverage is ruthless
Regardless of the reason traders are using leverage, there is a highly unusual imbalance in the margin lending markets right now that is favoring BTC longs betting on the price going up. Despite this, movement in margin markets has been limited so far as BTC futures markets have remained relatively calm throughout 2023.
Margin markets work differently than futures contracts in two main areas. These are not derivative contracts, which means trading takes place on the same order book as regular spot trading and unlike futures contracts, the balance between margined longs and shorts is not always even.
For example, after buying 20 Bitcoin with margin, you can literally withdraw the coins from the exchange. Of course, trading requires some form of collateral or margin deposit, and this is usually based on stablecoins. If the borrower does not return the position, the exchange will automatically liquidate the margin to repay the lender.
The borrower must also pay an interest rate on the BTC bought on margin. Operating procedures vary between marketplaces held by centralized and decentralized exchanges, but usually the lender decides the rate and duration of the offerings.
Margin traders can trade either long or short
Margin trading allows investors to leverage their positions by borrowing stablecoins and using the proceeds to buy more cryptocurrency. When these traders lend bitcoin, they use the coins as collateral for short positions, meaning they are betting on the price going down.
Because of this, analysts monitor the total lending amounts of Bitcoin and stablecoins to understand whether investors are bullish or bearish. Interestingly, Bitfinex margin traders entered their highest long/short ratio on February 26th.
Bitfinex Margin Bitcoin Longs/Shorts Ratio. Source: TradingView
Historically, Bitfinex margin traders have been known to quickly build up margin positions of 10,000 BTC or more, indicating the involvement of whales and large arbitrage desks.
As the chart above shows, on Feb. 26, BTC/USD long (bull) margin demand exceeded short (bear) margin by 133 times at 105,300 BTC. Prior to 2023, this indicator last hit an all-time high in favor of longs on September 12, 2022. Unfortunately for bulls, the result benefited the bears as Bitcoin plunged 19% over the following six days.
Traders should cross-check the data with other exchanges to ensure the anomaly is occurring market-wide, especially as each marketplace has different risks, norms, liquidity and availability.
For example, OKX offers a margin lending indicator based on the stablecoin/BTC ratio. At OKX, traders can increase their exposure by borrowing stablecoins to buy bitcoin. On the other hand, Bitcoin borrowers can only bet on the fall in the price of a cryptocurrency.
OKX stablecoin/BTC margin lending ratio. Source: OKX
The chart above shows that OKX traders’ Margin Lending Ratio increased in February, suggesting that professional traders have been building leveraged long positions, despite the fact that Bitcoin price broke resistance several times between February 16th and 23rd failed to break through $25,000.
Additionally, as of Feb. 22, OKX’s margin ratio was the highest level in over six months. This level is highly unusual and aligns with the trend at Bitfinex, where a severe imbalance favored bitcoin margin longs.
Related: Can Bitcoin hit $25,000 again in March 2023? Follow market talks live
The difference in leverage costs could explain the imbalance
The rate for leveraged BTC longs at Bitfinex has been almost non-existent throughout 2023 and is currently below 0.1% per year. In short, traders should not panic considering that the cost of margin lending remains within what is considered healthy and the imbalance in the futures contract markets is non-existent.
There could be a plausible explanation for the movement that didn’t happen overnight. For example, one possible culprit is the rising cost of lending stablecoins.
Instead of the minimum rate offered for bitcoin loans, stablecoin borrowers pay 25% per year on Bitfinex. Those costs rose significantly in November 2022 when leading derivatives exchange FTX and its market maker, Alameda Research, exploded.
As long as bitcoin margin markets remain extremely unbalanced, traders should continue to monitor the data for additional signs of stress. No red flags are being raised at this time, but the size of Bitfinex BTC/USD longs ($2.5 billion position) should be a cause for concern.
The views, thoughts, and opinions expressed herein are solely those of the authors and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article does not contain any investment advice or recommendation. Every investment and trading move involves risk and readers should do their own research when making a decision.
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