13 Sep 2022

ETH perps seeing massively negative funding rates

Ethereum perps are seeing a massive plunge in funding rates as traders actively seek to hedge ahead of the merge, a buy-the-news story in the making? Meanwhile, CME BTC futures recover into contagion, while OI remains at all-time highs.
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Ethereum perps are seeing a massive plunge in funding rates as traders actively seek to hedge ahead of the merge, a buy-the-news story in the making?
Source: Skew
Yesterday, the accumulated funding rate on FTX’s ETH perp reached -0.94%, meaning that shorts had to pay 0.94% in daily compensation to longs to hedge ahead of the merge. FTX’s funding rates update at an hourly interval. If the current funding rate regime of approximately -0.06% per hour until the Merge, shorts will pay approximately 2.4% in fees to longs.
Three strategies may fuel the aggressive shorting:
  1. Cash neutral exposure, with a 1:1 allocation of ETH spot vs. ETH shorts. If the funding rate remains as low as now, and such a short is held until the merge, hedgers will pay 2.4% in fees for an airdrop token which is currently valued at 1% of the ETH market cap.
  2. Hedging a failed merge. If the merge succeeds, shorts may unwind. Prices may react positively to this flow if spot positions are maintained.
  3. Downright bearish bets on Ethereum, either due to a failed merge or a classic sell-the-news event.
Ethereum has weakened versus BTC in the last week, falling from a high of 0.085 ETHBTC to 0.077 ETHBTC, suggesting that some have already rotated to BTC ahead of the merge. Crypto has a rich history of known positive events becoming sell-the-news-events. In bitcoin, more or less all known massive events in newer history have coincided with the typical sell-the-news reaction. This occurred during the CME futures launch in 2017, the ICE futures launch in 2019, Coinbase’s IPO in 2021, El Salvador’s BTC adoption day, and the spot ETF verdict. Still, all these sell-the-news events saw vastly different derivatives activity, with derivatives traders then punting long exposure. This time, derivatives are in a vastly different state, with a huge focus on hedging. In the likely event of a successful merge, we might be in for a rare buy-the-news event in crypto as traders unwind hedges, having a positive impact on the overall market.
CME basis recovers
CME’s period in backwardation ended last week, driven by ETF traders reducing their downside exposure in anticipation of potential upside in BTC.
Source: Skew, Laevitas, Tradingview, CME
Bitcoin futures has seen an uplifting trend in the last days following BTC’s recovery from range lows, with the futures basis climbing to 2% across all venues. CME has seen the strongest recovery, with its futures no longer trading at a discount to spot. The key source behind this recovery is likely the ETF flows, with short-covering having a positive impact on CME’s basis. After CME’s recovery, the CME basis now aligns with the offshore basis. In addition, CME’s front-month futures currently trade at a premium to other offshore venues for the first time since early August. The basis offshore has also recovered over the last seven days. Currently, the basis has climbed to mid-July levels. While the climbing basis suggests a more optimistic outlook from BTC futures traders, a 2% annualized basis is low through historical lenses. Overall, traders still seem to be cautiously positioned, with a considerable willingness to protect for further downside. Nevertheless, the recovery suggests a breath of optimism in the market and coincides with BTC strengthening, both versus Nasdaq and versus ETH, amid a very interesting macro and crypto week.
Funding rates climbing to neutral levels
Funding rates reached neutral levels amid BTC’s Friday recovery.
Source: Skew, Bybit, Binance
We saw a short squeeze in BTC perps leading to the funding rate recovery on Friday as $130m worth of shorts got liquidated. This is the largest short liquidation volume seen in BTC since June 13th but is still negligible in size compared to previous squeezes.This short squeeze had a minor impact on open interest, which remains high, as illustrated below.Funding rates have since declined slightly but remain higher than prior to the Friday recovery, suggesting a fairly balanced demand to enter longs and shorts in BTC.Still, while funding rates have recovered to neutral terrain, the extended periods of funding rates below or at neutral prevails. December 3rd is the last time funding rates climbed above neutral levels.
BTC denominated open interest at all-time high
Open interest in perps sees further growth – now sitting at 418,000 BTC. BTC denominated open interest in perps stays high and reached a new all-time high last Wednesday of 421,000 BTC before experiencing a minor setback amid the Friday short squeeze.
As noted previously, the open interest has not been heavily impacted by BTC crashes, suggesting that longs are conservatively leveraged in BTC derivatives. By illustrating the open interest in notional value, we get a sense of the relative degree of leverage in the market, removing noise introduced by BTC’s inherent volatility. On Wednesday, the combined open interest in BTC perps and futures reached a new all-time high, surpassing the previous February 2020 peak. In February 2020, the growth was accompanied by an elevated futures basis and positive funding rates. Then, leverage was more concentrated on upside bets, leading to the cataclysmic days of March 12th. Now, the growth has occurred amid a prolonged depressed sentiment, and it’s fair to assume that the market is less exposed to a March 12th-like crash. Open interest may remain high for extended periods, but this new paradigm is unlikely to last. Allocation into derivatives involves funding costs, and positions are bound to unwind somewhere down the line. The strong constant growth in OI, with negligible declines during the Luna and 3AC collapses, suggests that shorts have been at the wheel throughout the rise. Once uncertainty is lifted from the market related to the pressuring macro backdrop, regulation, and the Ethereum merge, it’s certainly plausible that hedges will be unwound, which may have positive implications for the BTC price.
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