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Bitcoin Perpetual Funding Rates Crash as Price Slide Puts Short Volatility Bets at Risk

Aug 18, 2023 at 11:12 am

Funding rates across various global exchanges for Bitcoin (BTC) perpetual futures witnessed a significant decline late on Thursday. This plunge in funding rates was a direct consequence of an abrupt drop in Bitcoin's price, putting short volatility bets, which had gained popularity recently, in a precarious position.

Perpetual futures contracts are derivatives without an expiration date, and they utilize a funding rate mechanism to align perpetual prices with the index price. A negative funding rate indicates a prevalence of bearish short positions, causing shorts to pay longs to maintain their positions. Conversely, positive rates suggest the opposite scenario.

On Thursday, funding rates on exchanges like OKX, Deribit, and Bybit plummeted to -10% or even lower on an annualized basis. Simultaneously, Bitcoin's average price plummeted to $25,392, as reported by Velo, a data source. The Deribit Implied Volatility Index for Bitcoin DVOL, which measures the anticipated price turbulence over a 30-day period, surged from an annualized 36% to 48.5%.

Possibly, traders who had engaged in shorting options in recent weeks, a common strategy to profit during periods of reduced volatility, opted to sell perpetual futures to hedge against potential risks stemming from a sudden spike in volatility. This move drove perpetuals into a considerable discount and amplified the price drop.

Griffin Ardern, a volatility trader from the crypto asset management firm Blofin, explained, "For BTC, option sellers were short too many put options, for more investors were previously bullish, selling put options to finance buying call options to reduce costs. So the sudden and unexpected price drop lead to hedging behavior, catalyzing deeper decline."

According to certain anonymous market observers on Twitter, the notable markdown in Deribit's perpetual futures could be attributed to the exchange offloading perpetuals while simultaneously liquidating a substantial short volatility position.

Deribit holds an influential position in the crypto options market, accounting for almost 90% of the total market share. In simpler terms, a significant portion of volatility selling observed recently took place on Deribit's platform. At one point during the late hours of Thursday, Deribit's BTC perpetual futures were trading at a discount of $2,000 compared to the average spot price of Bitcoin across various exchanges.

Lukk Strijers, the Chief Commercial Officer at Deribit, disclosed that the exchange had recently adjusted its liquidation policy. He highlighted that the marked discount in perpetual futures was a result of negative funding rates across the globe.

"Previously, Deribit only auto-liquidated options positions using perpetual/futures when possible, which was a form of Delta hedging as the first step to manage risk. Since early August, directly closing options positions has been a part of the liquidation algorithm as well. That logic has been changed to liquidate with whichever instrument is causing the issue and, therefore, more effective," Strijers informed Bitsday

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